Wealthy earners’ retirement dilemma
JOHANNESBURG – The tax harmonisation of retirement funds will also see the introduction of a cap of R350 000 per annum on deductible contributions to pension funds, provident funds and retirement annuities on March 1.
This means that a number of high net worth individuals (HNWIs) who previously contributed in excess of R350 000 to retirement vehicles and who were able to deduct the full contribution from their taxable income, will now see the deductible portion of their contribution capped at R350 000. As a result, their take-home pay will reduce.
Kobus Hanekom, head of strategy, governance and compliance at Simeka Consultants and Actuaries, says the new cap may not be good news for fund members who contribute more than R350 000 per annum. This would generally include members who earn more than R1.27 million per year and who contribute 27.5% or more of their remuneration to a retirement vehicle.
A HNWI who earns R5 million per annum and who could previously claim a R750 000 contribution (15%) to a retirement annuity as a tax deduction, will now see the tax deductible portion of the contribution capped at R350 000.
These individuals may face some tough choices. Do they continue to contribute the same amount or explore other investment options?
While the actual number of people who stands to be affected by this requirement seems to be fairly small, the repercussions could be significant.
Data from the South African Revenue Service (Sars) show that 1 383 taxpayers contributed more than R350 000 to a retirement annuity in 2014. With regard to pension fund contributions, almost 60 individuals exceeded the cap during the same tax year. Contributions by employers are not reflected in the latter figure as these contributions are only taxed as fringe benefits in the hands of employees from March 1 this year, Sandile Memela, executive for media and public relations at Sars, says.
Vickie Lange, institutional best practice specialist at Alexander Forbes, says less than 0.5% of their members contribute R350 000 or more per annum to a retirement vehicle. Alexander Forbes administers several hundred thousand fund members.
In the fund or outside
Jason Appel, CFP® at Chartered Wealth Solutions, says ultimately the decision will depend on the personal circumstances of the individual.
Hanekom says the first option any person in this situation should consider is a tax-free investment, although these accounts currently cap contributions at R30 000 per annum, which will likely be small change for these individuals.
From a convenience point of view, it is difficult to trump an investment in a pension fund. The money is deducted and invested automatically and although it may not be as tax efficient as it previously was, it is still very competitive. Based on their calculations it is more tax and cost efficient than a comparable retail investment over longer investment terms. It is also protected against creditors, Hanekom says.
Moreover, returns within the retirement vehicle remain tax-free, which is a strong motivator as HNWIs will likely find it difficult to get returns anywhere else that will be enough to compensate for the tax that would be payable on a discretionary investment, Arno Loots, head of umbrella fund solutions at Liberty Corporate, adds.
Since the undeducted portion of over-contributions to a retirement fund is carried forward to the next year and eventually paid to the individual in the form of a tax-free pension, keeping the money in the retirement fund also helps the individual to derive some benefit in future, Loots says.
The alternative is to consider tax-efficient (international) or high growth products, but the former is unlikely to be as efficient as a retirement vehicle, and the latter will be hard to come by, he adds.
It is probably also reasonable to expect that investment firms will launch products to bridge this new gap in the market. Grindrod Asset Management for example has developed the Restricted Equity Plan, “an alternative savings product that allows companies to make equity awards to selected staff, the proceeds of which are invested in an equity fund and do not form part of the members taxable income whilst restricted”.
In some circumstances, the freedom of choice associated with saving in a discretionary investment outside the fund, may be a powerful alternative as savers may be able to bypass the requirements of Regulation 28 which caps exposure to individual asset classes, Hanekom says.
But liquidity is also an important consideration for many clients during their retirement planning, Appel says.
Clients may have considerable savings in a pension fund, but not enough cash to fund holidays, new cars or other capital expenses, as they may be limited to withdraw one-third of their benefit in cash at retirement (depending on the vehicle and how it is affected by the pension fund reforms).
Appel says if this is the case, they often encourage clients to build a liquidity pot outside their retirement fund.
“In this case I may not recommend that someone overcontribute to a fund, rather keep it to the R350 000 where they can, especially if they have a liquidity problem,” he says.
There is a place for all investment products, but investors should refrain from purchasing products before having a holistic financial plan in place. Making informed decisions and seeking appropriate advice are really important, Appel adds.
“Chasing tax saving in isolation to other needs can be detrimental to a retirement plan as there are many other considerations.”
HNWIs should also keep in mind that contributions made to retirement funds with after-tax money (in other words overcontributions) after March 1 2015 would form part of their dutiable estate. This applies to anybody who dies on or after January 1 this year, Lange says.
Tax legislation allows contributions in excess of R350 000 to be rolled over to the next year. Any undeducted contributions can be used to reduce the individual’s taxable income in retirement. The portion of these overcontributions that have not been used to reduce the tax liability in retirement by the time of death will be estate dutiable, she says.
“The earlier you die the less opportunity you have to get the tax deductibility in the future.”