So you’ve had the obligatory farewell lunch with colleagues you’d rather soon forget, and you’ve primed yourself for a life of carefree Nespresso mornings and pottering around to your fancy. The nice man from the financial advisory company is dealing with all the paperwork and you’re waiting eagerly for your first retirement ‘payment’.
Ever considered what that payment might be and how it finds its way to your bank account?
Chances are that if you have contributed to a pension fund or retirement annuity, then what you’re going to be receiving every month is an annuity of sorts.
Some of the single largest taxpayers in South Africa are the various policyholder funds within the life assurance companies that are responsible for looking after all your pension money. Every year they hold back billions of rands in tax from retirees’ monthly payouts and hand this over to SARS. They are obliged, like an employer would hold back PAYE, to withhold tax on annuity payments. This system allows for more efficient revenue collection by SARS.
Retirement is not just when you get to enjoy the fruits of your working career, it’s also the time at which SARS starts to claw back some of their previous benevolence.
For decades, SARS has been granting you deductions for all your RA and pension fund contributions, as well as forgoing tax on all the investment returns on your retirement savings. Theirs was a long-term plan, in that they knew that you would retire one day and start drawing an annuity. This is when they would take their share.
How much they take is no different to a salaried employee. The more you get from retirement, the more progressive the tax system.
This does have its benefits though. By reducing the percentage that you may choose to draw down against your retirement annuity, you can reduce your taxable income. A lower taxable income means you pay less tax.
In years in which your income may be subsidised by alternate sources, you could choose to draw dawn a smaller annuity. The effective tax rate that you pay on that smaller annuity would be less.
It’s like choosing to get a smaller salary.
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Part of coming up with a clever retirement plan, is diversifying your income sources. For once, this isn’t about avoiding risk, but increasing your monthly after-tax income. Some sources of income offer obvious tax benefits, like interest income. All natural person taxpayers are able to earn a certain amount of interest per year without paying any tax on it. We discussed this in a fair amount of detail when we talked about income tax on your money market unit trust.
Spreading some of your interest-generating assets between your spouse or partner, and yourself, will double the amount of tax-free interest that can be earned.
Dividend income, although effectively taxed at 20% (from March 2017 onward), offers another way in which you can earn an income stream, other than by way of a taxable annuity. Remember though that dividend yields are generally quite low, which means you’ll need more money tied up in dividend-generating assets to produce the same amount of income.
There are generally two types of annuities. A living annuity, and a Life Annuity.
A Life Annuity is something you buy, and in return you get a guaranteed income stream over a defined period of time. Typically if you die, it’s your heirs’ bad luck. You might take out a Life Annuity and pay R2 million for it, only to become a statistic two months later and effectively lose all your money.
The benefit of a Life Annuity is that you need not worry about what the stock markets might do, or whether or not the underlying Funds that your financial advisor chose will generate sufficient returns for you this year. That’s because the Life Company has promised to pay you that amount, and that amount they’ll pay. They bear the risk.
A Living Annuity is essentially a collection of Unit Trusts or Funds, all wrapped up under the umbrella of an annuity. To generate an income for you, some of your unit trusts are sold. These unit trusts will also generate returns like interest, dividends, and rental income.
The nice thing about a Living Annuity is that it has an inherent Life insurance policy built into it. If you die shortly after entering into a Living Annuity, the full amount can be left to your spouse or heirs – after tax of course.
Where leaving money to your dependents is important to you, a Life Annuity is probably not the best option. On the other hand, if you have a smaller amount of money and are not able to tolerate volatility in financial markets, getting a guaranteed return from your friendly life insurance company might not be a bad idea.
These are all important discussions you’ll need to have with your financial advisor when you get closer to retirement date.
We’ve written quite a few other great pieces on how tax affects your various investments and retirement outcomes – here they are:
If you have any questions on any of them, give us a shout!