Tax and investment planning through the lens

My recent articles extensively promoted the use of retirement annuities in financial planning. Some readers may interpret this as being a universal prescription that all investments should be housed in retirement annuities.

This cannot be the case for the following reasons:

  • Retirement annuities carry the requirement that the investor must stay within the fund until retirement age, currently 55. Although National Treasury has undertaken to reassess this requirement, it isn’t anticipated that much will change. Premature withdrawal will only ever be allowed in the narrowest of adverse circumstances, and even then a substantial portion of the withdrawal will be heavily taxed.
  • Retirement annuities cannot be fully invested offshore. And it’s often difficult to determine the extent of rand hedge investment strategy inherent to a retirement annuity investment.
  • Regulation 28 of the Pensions Fund Act effectively requires 25% of the retirement annuity fund to be invested in interest-bearing instruments. Given that current interest rates are below the official inflation rate, this means, at face value at least, a component of the retirement annuity fund investment is slowly fading away.
  • The playing field could change again in years to come. Twenty years ago retirement annuities received a lot of bad press due to enforced preservation and prescribed investment regulations coupled with retirement funds tax consequences. Although it isn’t anticipated that such regulations will be reintroduced, there can be never be an absolute guarantee.

This article seeks to address the aforementioned issues in some detail and develop a simple strategy of checks and balances.

Financial planning starts with a lifestyle plan

The most common question in financial planning is ‘what is the best investment?’ The follow-up question should always be ‘how long can you remain invested?’

As attractive as the retirement annuity funds tax profile may be, there’s simply no avoiding the reality that they’re useless if the investor requires access to the funds before age 55. Thus it’s essential to create a lifestyle plan to determine the extent of saving, investment and retirement planning within a financial plan. There’s nothing more flawed than a financial plan that doesn’t match the lifestyle plan.

Saving, insuring, investing and retirement planning

Many investors don’t appreciate the essential differences between saving, insuring, investing and retirement planning in the context of the overall design of a financial plan.

Saving should be a minor component of a financial plan. This is simply the pursuit of building up a war chest of accessible cash that’s available for the smaller challenges that life may throw at us, for example, payments needed for a wedding, funeral, new car etc. In short, saving is a strategy to overcome the shortfalls of having a fixed monthly income as opposed to a wealth creation strategy created through investment and retirement planning.

Saving is inherently based on interest-bearing deposits, as the cash must be readily accessible with no risk attached. Given current interest rates, the extent of saving should be confined to a minimum.

Some investors try to build up a cash portfolio sufficient to cover major emergencies such as retrenchment, disability or serious illness. In many cases the investor would be far better off insuring against these disasters rather than holding a substantial cash portfolio that’s going nowhere, if not backwards.

Generally, it’s submitted that the savings component of a financial plan should not exceed the cash requirements of the investor in the short term (six months to a year).

Remember that not only are interest rates very low but they’re also fully taxable (less an annual tax exemption of R23 800 per annum for investors under 65 and R34 500 per annum for those over 65). Taxation can reduce the after-tax interest rate to about 3%, which isn’t far off the current dividend yield rate and well below the inflation rate.

Some investors still hold on to the concept that accelerating home loan repayments is a foolproof investment strategy. They’re living in the past. In years gone by it was possible to achieve a tax-free return of 20% or more, well above the prevailing inflation rate. Those days are long gone and unlikely to ever return.

Once the taxpayer has determined the extent of savings required and implemented insurance cover against major emergencies, the debate can then move to investment strategy and retirement planning.

Investment strategy

Investment strategy should be divided into two components:

  • the personal investment portfolio, accessible prior to retirement
  • the retirement fund portfolio

The most important issue with regard to investment portfolios is that time is needed to manage the risk associated with equity investments. This is the essential difference when compared with the savings portfolio. The personal investment portfolio should be semi-permanent in nature, only to be liquidated in exceptional circumstances.

The stark reality of the vulnerability of the rand should be addressed in the personal investment strategy. South Africans make far too little use of the offshore allowance of R4 million per taxpayer. Remember, this facility can be doubled when making an investment plan for both husband and wife. Or even further once children have reached the age of 18. Thus, for most South Africans, exchange control regulations have little effect on financial planning.

Offshore investment portfolios carry high risk as the risk of foreign equity markets is coupled with exchange rate risk. Consequently, offshore investment portfolios have to be viewed as very long-term investments in order to manage the higher risk.

Returns on offshore portfolios generally take the form of capital gains, even if they comprise exchange rate gains. As such, the maximum tax exposure can be contained at a maximum of 13,3% and is subject to an annual tax-free exemption of R30 000. The recent change from secondary tax on companies to dividends tax has resulted in offshore dividends being subject to a maximum tax rate of 15%. Thus the tax exposure of the offshore portfolio isn’t substantial, certainly far less than the savings portfolio.

The retirement portfolio

The appeal of the tax status of retirement funds is substantial:

  • a tax-deductible contribution, limited from 1 March 2015 to 27,5% of taxable income or R350 000 per annum
  • tax-free growth within the retirement fund
  • partial taxation on leaving the retirement fund
  • a complete estate duty exemption on death.

The above tax profile can’t be matched, particularly if the tax saving on contributions is reinvested within the retirement fund.

The investor should certainly seek to maximise contributions to retirement funds to the extent of the tax-deductible contribution. However, now that non-deductible contributions can be returned to the taxpayer tax-free on withdrawal or death, there remains less of an incentive to even make non-deductible contributions.

The overall objectives and priorities


The younger investor will prioritise the establishment of an insurance and savings portfolio.

The older investor would have hopefully already established a savings account and insurance portfolio. Thus funds should be directed towards the investment and retirement portfolio.

The retired investor

The above observations may suit the investor prior to retirement, but what of the investor already retired?

Traditionally, the retired investor prefers to reduce all investments back to savings accounts in order to have ready access to cash and reduce investment risk. This logic may have been suitable in times of high interest rates and lower life expectancy. But that’s now changed.

The retired investor is seeking a combination of a low tax exposure and ultimately an estate duty saving. Furthermore, the retired investor is seeking a return well above the current fully taxable interest rate. None of these objectives will be achieved through savings accounts where interest is fully taxable and the savings account is included in the computation of estate duty. There’s also been significant change in that investors can contribute to a retirement annuity regardless of age (previously, a cut-off point on contribution was applied at age 70).

Today, the living annuity concept is the obvious solution whereby the retired taxpayer can continue to enjoy the full benefits of the retirement annuity fund without having to purchase a life annuity. Anything remaining in the living annuity on death can be passed onto the estate beneficiary without incurring any estate duty liability.

The retired investor may wish to reposition the retirement annuity fund portfolio to reduce risk. This can be achieved without exiting the retirement fund but rather by rebalancing the portfolio. The important issue being that interest receipts resulting from a more conservative investment mix will remain tax-free while retained in the retirement annuity fund.

Cash requirements from the retirement annuity funds can be withdrawn by way of a lump sum or an annuity of up to 17,5% of the accumulated fund.

A final note

In the past, retired investors sought to liquidate all portfolios to cash prior to death. It’s quite ironic that today an investor can legally liquidate everything and contribute it all to a retirement annuity fund prior to death, thereby completely avoiding estate duty liability.

My, how the world has changed!

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