More than 50 percent of retirement fund members in South Africa need to take urgent action, as they face retiring with a pension of less than 30 percent of their final pay cheques. And even if you are in the 10 percent who will be financially secure in retirement, you may still need to top up your retirement savings.
The low percentage of retirement fund members who will be financially secure in retirement was revealed by recent research undertaken by financial services company Alexander Forbes. And now new research shows the situation could get worse as more people live longer and need more money in retirement (see “Retiring nowadays is no walk in the park”, below).
If you haven’t made sufficient provision for your retirement, you have an opportunity to improve things. You have two weeks left in this tax year in which to take advantage of Finance Minister Pravin Gordhan’s annual tax break, which will help you to fill up your retirement coffer at a big discount.
Gordhan’s offer to reduce your tax liability for 2010/11 expires at the end of the tax year on Monday, February 28. The annual offer is on a use-it-or-lose-it basis.
If you are on the top marginal income tax rate of 40 percent and you contribute 15 percent of your non-retirement-funding income to a retirement annuity (RA), you can claim your contribution as a deduction. In effect, Gordhan adds 40 percent to the amount you contribute to your retirement savings! If you are on a 30-percent marginal rate, you get an effective 30 cents in the rand.
The reason is that you will not be paying tax on the rands that you contribute to retirement savings. If you want to reduce your tax liability for the year, you will have to do your sums this weekend to give yourself and a product provider sufficient time to top up your retirement savings before the deadline. Until three years ago this tax break was limited to people under the age of 70. Now it applies to everyone.
The tax laws allow you to deduct limited amounts from your taxable income to fund your retirement (see “Tax incentives for savers”, below).
It is not that you never pay tax on your retirement-funding savings; you do, but only when you draw the money as a pension when you are in retirement. In the meantime you get to use the money you did not pay as tax to receive tax-free investment returns, which again are taxed only when you withdraw the money.
The tax breaks do not end with claiming a deduction against your retirement-funding income. Retirement savings are packed with other tax breaks, including:
* Investment growth on deferred tax. By investing in a retirement-savings vehicle, you are effectively deferring the payment of tax until you retire. The money you do not pay in tax is also earning returns until you withdraw it as a pension and/or a lump sum.
* At retirement, the first R300 000 of any lump sum you take from a retirement fund benefit is tax-free. The next R300 000 is taxed at 18 percent, the next R300 000 at 27 percent, and any further amount is taxed at 36 percent. These amounts are cumulative and cannot be claimed more than once.
* Any amount used to purchase a pension is taxed only as and when you receive your pension payments. Many people are taxed at a lower rate once they reach 65, when the effective tax rate is lower because of the pensioners’ secondary rebate. This means you are paying less tax on the same rand than you would have paid when you earned it.
* The underlying investments in tax-incentivised retirement vehicles are not subject to capital gains tax (CGT) or to income tax on foreign dividends and net interest earnings. This is an advantage over other savings products, which are subject to both income tax and CGT, either in your hands or in the hands of the portfolio/product manager.
* When you die, your savings in a tax-incentivised retirement vehicle can be paid directly to your dependants or beneficiaries either as a lump sum or as an annuity (regular income stream).
Note: It is important to name dependants or beneficiaries to assist the fund trustees in the distribution of your accumulated benefits if you die before retirement. After retirement, where there is a capital residue available to beneficiaries, you decide, without interference, who gets the money on your death.
TAX INCENTIVES FOR SAVERS
The two main ways to save for retirement and take advantage of the tax incentives are through occupational and voluntary retirement funds.
If you are a member of an occupational retirement fund (normally sponsored by an employer or a trade union), you may deduct from your taxable income your contributions to the fund of up to 7.5 percent of your retirement-funding income (retirement-funding income normally excludes income such as a travel allowance).
But even if you are a member of an occupational fund, you can save more for your retirement through a voluntary fund such as a retirement annuity (RA).
If you are saving money in an RA, you may deduct from your taxable income the contributions you make to that RA of up to 15 percent of your non-retirement-funding income.
In other words, exclude the portion of your pay that is used to calculate your contributions to your occupational retirement fund. Add up any other income you may receive – from sources such as a travel allowance, overtime and interest earnings – to calculate the maximum amount you are allowed to deduct, for tax purposes, from your taxable income.
RETIRING NOWADAYS IS NO WALK IN THE PARK
If you retired in 1960, you would have needed a lump sum of about 8.1 times your annual income to be financially secure.
Today, if you are a man, you need a lump sum of at least 10.5 times your income to retire financially secure.
If you are starting work today at age 20 and expect to retire in 40 years’ time, you will need 11.3 times your final income.
For women the figures are 9.8 times in 1960, 12.5 today and 13 in 40 years’ time. Women need a larger lump sum because they live longer than men on average.
The required lump sum is increasing because we are living longer and need more money in retirement, Willem Loots, an actuarial manager at Liberty Corporate Consultants and Actuaries, says.
The average life expectancy in 1960 was 70.8 years for women and 65.8 years for men in member countries of the Organisation of Economic Co-operation and Development. By 2006, life expectancy in these countries had increased to 81.7 years for women and 76 years for men.
But your ability to save more money is often under attack.
The global recession resulted in many people deviating from their financial plans over the past year, including cutting back on retirement fund contributions, Gerhard Joubert, the head of group marketing at financial services mutual company PPS, says. The problem was exacerbated by significant cuts to interest rates, which lowered returns on retirement savings, he says.
“Stopping or reducing retirement saving contributions, even for a relatively short period, can have a massive impact on the final values at retirement, due to the power of compound interest.
“If you have reduced or stopped contributing to a retirement annuity or pension fund, it is important to ensure you resume contributions and, if possible, make up for the shortfall,” Joubert says.
Loots says one solution is to increase your years of employment. This will give you more time to save for retirement and to reduce the time you spend in retirement, so you will need less money in retirement.
For a man who retires at age 70 in 2050, the effect of saving longer and drawing a retirement income for a shorter period is expected to result in a drop in the required annual retirement savings contribution rate from 15 to 10 percent of pensionable income.
However, Joubert concedes that most members of South African funds have no choice as to when they can retire. He says you will have to be inventive in order to extend your years of employment, such as by taking semi-retirement with a scaled-down workload.
CHANGES IN THE PIPELINE
Finance Minister Pravin Gordhan’s generous offer is not likely to be around forever. The government’s proposals to reform the retirement-funding system include placing a cap on the amount you may claim as a tax deduction, particularly because the government intends to make it compulsory for you to save for retirement.
But in the meantime, all of us, including the very rich, can get the taxman to subsidise our retirement savings.
The best way to take advantage of the tax break to top up your retirement savings is to buy a retirement annuity (RA) or add a lump sum to an existing RA to raise your contributions to the maximum amount you are allowed to deduct from your taxable income.