In managing our financial affairs, just as in sports, there are rules to keep all the players in line. As we have witnessed all too often during the recent Rugby World Cup in Japan, those who play to the limits of the law, but do not overstep them, are generally the players who thrive and excel. It is important to make maximum use of every legal loophole or benefit on offer.
The South African government provides a number of incentives to individuals to urge us to save for retirement. Failing to make use of these benefits on offer, can lead to diminished retirement rewards and insufficient funding. Ecsponent Financial Services General Manager Marietta Du Preez advises savers to do the equivalent of “playing to the whistle”.
“The government recognises that it is up to individuals to fund their own retirement, since social security is already under tremendous strain. To guide us in this process, SARS provides tax benefits to people who contribute to a retirement annuity, which the government has recognised as a retirement savings vehicle,” says Du Preez.
Designated retirement annuities allow investors to boost their personal income every tax year by taking advantage of the tax benefits on offer. This includes being able to contribute up to 27.5% of an individual’s taxable income, up to a maximum of R350 000 each year, towards a retirement annuity. The contributions will be deducted from an individual’s taxable income.
“The voiding of tax on these contributions is hugely important because it allows you to boost your savings, which will allow you to take advantage of the effect of compounding. The more you have in your retirement annuity, the greater the compounding benefits,” she says.
Using an example, an investor who is 40 years old and has 20 more working years ahead, could invest a Christmas bonus of R30 000 into a retirement annuity, and just that R30 000 capital would eventually compound to R80 000 in 20 years at a growth rate of 10% per annum (with all costs and fees taken into account). Now imagine the compounding effect of a full R350 000 allowance per year.
Another alternative is to use a tax-free savings account. There are a wide variety of TFSAs on offer from financial services institutions, but these are not the same as tax-free savings accounts at a bank.
“These concepts are often confused. A tax-free bank account for cash deposits might only tax interest paid back to the holder and not the underlying capital, but a TFSA offers actual capital growth because the money is invested on your behalf, and there is no tax on capital gains of dividends paid back to you,” says Du Preez.
Since March 2015 South Africans have been able to invest R33 000 per year, or R2 750 per month, into TFSAs in a full tax-free investment, up to a lifetime maximum of R500 000.
“If individuals invest to the maximum allowance religiously, after approximately 17 years they will reach their R500 000 investment limit and will reap all the rewards of capital growth, interest and dividends. This can be a significant boost to anyone’s retirement capital,” says Du Preez.
Another, less well-known tax break option is a Section 12J Investment, introduced into the Income Tax Act to provide individuals, companies and trusts with a tax incentive to invest in venture capital companies (VCCs).
“These investments are used by VCCs to fund small- and medium-sized enterprises that are believed to have long-term growth potential in economic sectors that are often hard-pressed for financing. The aim is to encourage investors to participate in the capitalisation of these businesses, which will stimulate economic growth and create jobs, while providing returns for the investors when the VCCs ultimately sell their stakes in the businesses once they have grown in value,” Du Preez explains.
Unfortunately, she says, most people cannot and should not make use of this tax break because VCCs require a minimum of R100 000 – with some products require an investment of up to R500 000 at a time.
“The ideal investor for this kind of asset would be somebody in the top marginal tax bracket of 45%, who has already reduced their taxable income with the maximum tax-efficient options, like the contributions to a retirement annuity or tax-free investment vehicle.
“The problem comes in when people invest into these funds without fully understanding the implications on the VCCs’ resale of shares and how long that may take, as well as the possible tax penalties that could follow. Especially during times of market turmoil or an expected economic downturn, without fully understanding the intricacies or limitations of such investments, one can find oneself stuck in a bubble waiting to burst,” she says.
As always, due to the fine print and options on offer, Du Preez cautions against making any decisions without consulting a registered financial adviser.