Since their introduction in March last year, tax-free investment (TFI) products are increasingly gaining traction in the market place. Considering investors benefit from paying no income tax, capital gains tax or dividend tax on the proceeds generated by these products, on the surface investing in a TFI seems like the right way to go. However, as with any investment, investors need to weigh up whether opting for a TFI is in line with their short- and long-term investment goals and even more importantly what the potential tax benefits are. So, let’s compare the tax benefits of TFIs as opposed to those yielded by traditional retirement annuities (RA).

 

In short, a TFI can be regarded as a long-term savings tool where investors stand to benefit from exponential impact of compound interest that over time ensures the investment value realised at the end of the period is significantly higher than in a discretionary investment. Tax-free savings accounts allow investors to invest a maximum of R30 000 per annum, or R500 000 in the investor’s lifetime, with all the proceeds earned on this investment being entirely tax-free.

 

However, bear in mind that if you exceed your contribution limit, SARS will levy a 40% penalty on the portion of the contribution above the threshold. Additionally, contributions to TFIs are not tax-deductible up-front and it is only proceeds that you withdraw at the end, that are tax-free. In this respect TFIs differ greatly from a RAs, in that with an RA, your tax liability is deferred. However, bear in mind that your investments in an RA cannot be accessed before the age of 55, whereas you can access your TFI any time.

 

The three biggest tax benefits RAs offer are:

  • Contributions are tax deductible– investors may deduct up to 27.5% of their gross remuneration or taxable income (whichever is the higher) in respect of the total contributions to an RA. However, this is subject to an annual limit of R350 000.
  • Investment returns are tax-free within the RA and there is no income tax or capital gains tax on the investment return earned in a RA.
  • Benefits, once paid out at age 55, are taxed favourably – lump sum payments are taxed on a sliding scale with a portion of the benefit tax free as indicated in the table below. Compulsory annuity payments are included in the taxpayer’s income in the tax year that the payments are made.

 

Tax Rate Withdrawal Lump Sum Retirement Lump Sum
0% 0 – R25 000 0 – R500 000
18% R25 001 – R660 000 R500 001 – R700 000
27% R660 001 – R990 000 R700 000 – R1 050 000
36% R990 001 + R1 050 001+

Source: South African Revenue Service

 

If you want to withdraw a lump sum amount from your RA, the first R500 000 of the withdrawal is currently tax-free, but limited to one-third of the fund value, which includes any pre-retirement withdrawals. The rest of the benefit must be transferred to an income-providing product, such as a living annuity or a guaranteed life annuity.

 

Your income tax liability on these income providing products is likely to be lower than when you were making contributions to your RA because by the time you reach retirement, your tax rate is likely to be reduced, and this is where the additional tax savings comes in, which may save your as much as 50% in tax payments over your lifetime.

 

Take a look at Floris Slabbert’s explanation about tax-free savings plans versus retirement annuities –