Dear reader,
Thank you for your question.
First and foremost, I am going to start off by taking a detour from the above questions by briefly contrasting a retirement annuity and an endowment policy. These two investment policies offer tax benefits in a unique way; however, they differ distinctively in tax treatment.
Endowments provide tax advantages to investors with marginal tax rates above 30%, lowering the amount of tax due on the growth of your investments. Furthermore, endowments promote discipline because the investment must be held for a minimum of five years. The investment is taxable in the hands of the investment life company notwithstanding its illiquidity because of the predetermined five-year lock-in time. In case of financial emergencies, there are restrictions on withdrawals made before the requisite five-year maturity.
In essence, if your marginal tax rate is more than 30%, an endowment policy makes meaningful sense as it is taxed within 30%.
Retirement annuities are a tax-saving vehicle where your taxable income is reduced up to a set limit, as spelt out in the Income Tax Act. Within a given year, contributions are tax deductible up to a maximum of 27.5% of taxable income or remuneration from your employer, with a R350 000 annual ceiling.
Additionally, contributions in excess of the stipulated limits can be used to lower potential taxes due on cash lump sums taken prior to or at retirement age, as well as to lower the taxable component of your living annuity income in retirement. Subject to the yearly limits, contributions made directly by your employer are also taxable as fringe benefits in your hands; however, the contributions are also tax deductible at your disposal but are subject to the above-mentioned allowable annual limits. Coupled with that, excess contributions can also be carried over and deducted in the next tax year thus reducing your tax liability.
Based on the above, in my opinion, I would rather suggest the following investment options for your excess contributions:
Retirement annuities
Continue investing in a retirement annuity for the following reasons:
- Upon withdrawal of a cash lump sum prior to or at retirement age, the excess contributions are tax deductible, thus reducing your tax liability.
- Carried-over excess contributions will reduce the tax payable on your living annuity.
- By nature, tax payment on your proceeds is deferred until retirement, thus allowing your investment to compound tax-free and undisturbed.
Retirement annuity and endowment
Allocate the excess contributions equally between the retirement annuity and endowment policy using a debit order facility. With regard to the latter, after five years, the proceeds from an endowment policy are exempt from personal income tax in your hands. Lastly, an endowment would be significant if your marginal tax rate is more than 30%.
Tax-free savings account:
Another alternative would be to place these excess contributions into a tax-free savings account. Interest, dividends, or capital gains earned will be tax-free in your hands. The growth of your investment and any withdrawals from your account are therefore not subject to taxation. However, the annual allowable contribution limit is R36 000 per tax year, with a lifetime contribution maximum limit of R500 000.
Unit trusts
I would choose to deploy these excess funds into unit trust investments. Unit trusts provide flexibility, diversification, capital growth based on your risk tolerance and investment strategy, liquidity, and advantages for estate planning. These investments can augment your retirement income depending on your investment horizon, but it should be noted that withdrawals or switches from this type of investment may result in capital gains tax.
Direct offshore
Finally, you might think about investing the excess contributions offshore. Offshore investments allow you to invest in foreign currency denominated (USD, GBP, CHF etc) underlying funds. The investment benefits from the performance of the underlying funds and the exchange rate fluctuations.
Minimum investments start from R20 000 to R50 000, depending on the product provider you choose. It’s crucial to understand that when making direct investments offshore, you can only invest up to R1 million without applying for a tax clearance certificate; any amount invested above R1 million requires tax clearance from Sars. There is an R11 million annual cap on the amount you can invest abroad. When switching and withdrawing, this could result in capital gains tax.
We hope that the above answers your questions.
The aforementioned is based on personal opinion and shouldn’t be taken as advice. We urge you to speak with your financial planner and tax practitioner for specific advice tailored to your financial situation.
