Retirement funds are the best investment you will ever make

Most of us rely on investments to support our lifestyles and well-being, but we frequently become lost and confused. One reason for this is that the financial services industry has created confusion by selling a wide range of investment products indiscriminately.

 

By Wouter Fourie (CFP®)
Director of Ascor® Independent Wealth Management.

Wouter Fourie is Past winner of the FPI Financial Planner of the Year competition and the co-author of The Ultimate Guide to Retirement in South Africa and, Secure your retirement.

 

Now imagine an investment where:

• The contributions to it are tax-deductible*, and the first R550 000 can be withdrawn tax-free* upon retirement;

• Investment growth is tax-free on the underlying funds;

• The investment value is not part of your estate and is exempt from estate duty tax (savings of at least 20%) and executor’s fees (3.5% plus Vat) on the investment or its growth; and

• Investments and returns are protected from creditors.

Best of all, all of this is guaranteed!

*Subject to the Income Tax Act.

This investment is for retirement funds. Once you get past the marketing hype, these investments in pension funds, provident funds, and retirement annuities are the best money can buy!

From March 1, 2016, total contributions to retirement funds (pension, provident, and retirement annuity) are tax deductible up to 27.5% of the greater of remuneration or taxable income, with a maximum annual limit of R350 000. These calculations use taxable income that excludes lump sums. Any excess not used to calculate the deductible amount can be carried forward to the following tax year.

This means that for every R1 you invest for retirement, Sars will allow a deduction equal to your current marginal tax rate, which ranges between 18% and 45%.

This is best explained using an example: If your marginal tax rate is 30%, Sars will deduct 30 cents for each R1 you invest in your retirement fund. That means you only pay 70 cents for each R1 invested for retirement. This guarantees a return on investment of 42.85% (30/70 = 42.85%). This means that the higher your marginal tax rate, the greater your guaranteed return will be.

The table below shows the investment return resulting from the tax benefit at contribution.

Marginal Tax rate	Guaranteed Investment Return
18%	21.95%
26%	35.13%
31%	44.92%
36%	56.25%
39%	63.93%
41%	69.49%
45%	81.81%

Marginal tax rate and guaranteed investment return.

Remember that your retirement fund (pension, provident, or retirement annuity) is the “vehicle” for obtaining the tax benefit. You can benefit even more if you select an appropriate “engine” that will generate investment returns.

A well-diversified balanced portfolio, like the AssetMix Balanced Fund, will produce long-term returns that outperform inflation. Thus, growth at a rate greater than inflation, combined with additional tax benefits, makes this potentially the best investment you will ever make. Yes, even better than paying into a house bond or paying off debt.

R550 000 tax-free

A very important factor to consider is that when you reach retirement age, which is 55 or older under current tax legislation, you will be eligible to receive the first R550 000 of your retirement fund contributions tax-free. So, your pre-retirement contributions were tax-deductible, but your retirement income is tax-free. The tax savings on the R550 000 tax-free portion are thus permanent.

Reduced income tax rate after retirement

Most people earn and pay taxes at their highest rate right before retirement. Most people will have less taxable income after retirement than when they were paid a monthly salary. The lower monthly taxable pension income, combined with the larger tax rebates after age 65 and 75, will result in a lower average tax rate after retirement.

As a result, while contributing to retirement, you save tax at a higher rate, and when you retire, you pay tax at a reduced rate. In effect, this difference represents an additional guaranteed return on tax savings after retirement obtained by using a retirement savings vehicle (pension, provident, or retirement annuity). This is in addition to the previously mentioned benefits (no estate duty tax, no executors’ fees, protection from creditors, etc.).

To demonstrate this, I’ll provide a simple practical example. If you earn R50 000 per month, your average tax rate after rebates is 22.60% (under the age of 65). When you retire at the age of 65, you receive the first R550 000 tax-free. That is a guaranteed 22.60% return on investment for the first R550 000!

If we use the above salary of R50 000 per month and you have saved enough for retirement and are able to receive a 70% replacement ratio (70% of your last salary is R35 000), your average tax rate falls to 15.72%, resulting in a permanent tax savings of at least 6.88% (tax saved when contributing at 22.60% versus tax paid on income during retirement at 15.72%), and it gets even better for money withdrawn from your pension after age 75.

Even if your investment growth is zero over the long term, which is very unlikely, the tax benefit alone makes it a “no-brainer”. To reap the greatest benefit, make the maximum tax-deductible contribution to your retirement funds. This will also help provide you with an income in retirement. This is commonly referred to as “paying yourself first”.

It is never too late to start contributing to your own retirement fund. February 29 is the deadline for “topping up” your retirement funds for the current tax year. Don’t miss out on this opportunity!

“The greatest risk in investing is your own behaviour,” said Warren Buffett.

In conclusion, a secure retirement requires careful planning, professional advice, and an active role in managing your retirement funds.

My best-seller book, The Ultimate Guide to Retirement in South Africa, co-authored with award-winning editor Bruce Cameron, provides readers with comprehensive information on retirement planning in South Africa. For more information about the book visit www.retirementplanning.co.za 

 

This article first appeared on moneyweb.co.za at https://www.moneyweb.co.za/financial-advisor-views/retirement-funds-are-the-best-investment-you-will-ever-make/

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