ARE ANNUITIES OR UNIT TRUSTS BETTER?
I will receive about R500 000 in interest when a R1-million fixed deposit matures in two years, when I will be 62. I will probably re-invest the capital in a five-year fixed deposit. I have a few small (less than R500 000) retirement annuities (RAs) that will mature at various times in the next five years. I plan to retire at 65, or older if I can keep working.
How should I invest the R500 000 to provide for my retirement? Should I buy a living or a guaranteed annuity? Should I invest it in unit trust funds and withdraw a percentage each month only when I retire?
I will need an income of about R15 000 a month when I retire.
Chris Nortier
Magdeleen Cornelissen, a financial adviser at PSG Wealth in Menlyn, Pretoria, responds: There is no simple answer to your question. There are potential benefits to investing in either annuities or unit trusts. Furthermore, I am not familiar with your investment portfolio and financial needs, information that is crucial for drawing up a financial plan. It is important that you have a financial plan that clearly stipulates your goals and objectives. This will guide you in choosing the most appropriate investment vehicle.
However, I shall set out the key points to guide your thoughts in the right direction.
Contributions to retirement funds, including RAs, are tax-deductible up to 27.5 percent of the greater of your remuneration or taxable income (excluding any retirement fund lump-sum benefit, withdrawal benefit or severance benefit). The deduction is capped at R350 000 a year. Any contributions that cannot be claimed in one tax year may be carried forward to the next year. However, the income from a living annuity or guaranteed annuity is taxable.
It is important to remember that you must first invest in a retirement fund before, at retirement, you can invest the proceeds in an annuity.
You need to analyse your overall investment portfolio before over-allocating assets to retirement funds. Be sure to take all your future discretionary capital needs into account, because you cannot make ad-hoc withdrawals from a living or guaranteed annuity.
Your financial adviser should discuss with you the differences between a guaranteed and a living annuity. One of the advantages of a living annuity is that pensioners can adjust their annual income between 2.5 and 17.5 percent of the capital value of the investment. This allows you to structure your income tax-efficiently, creating a balance between withdrawals from your discretionary funds and non-discretionary funds. At death, you can leave any residue to your heirs.
Although guaranteed annuities have certain benefits, you must understand the consequences if you decide to invest in one of these products. A guaranteed annuity has more restrictions than a living annuity or a unit trust fund.
Another option to consider is a voluntary annuity, which does not necessarily have a term linked to your lifespan. Please ask your adviser for more information about this product.
There are no tax advantages to investing in a discretionary unit trust portfolio, and any capital in the portfolio will be included in your estate for estate duty purposes when you pass away. However, once you turn 65, you benefit from certain tax breaks on your income. The main benefits of unit trusts are that you are free to decide how to allocate your money across the asset classes and you can invest additional capital or make withdrawals when it suits you.
Investors must take into account that they need discretionary investments to fund expensive purchases, such as a car. Younger investors with a longer investment time horizon can fund capital outflows from various sources, including bonuses and loans, but it becomes more difficult to raise capital once you are no longer earning a regular salary.
WITHDRAWAL FROM A PROVIDENT FUND
When I retired a few years ago, I withdrew just under R300 000 as a tax-free lump sum from my pension fund and bought an annuity with the balance. At the time, I also had a small amount invested in a provident preservation fund, which I did not withdraw. This amount has grown to about R200 000. I recently asked the fund manager whether I could withdraw this money tax-free.
I thought this would be possible because the provident fund benefit was below the R247 500 threshold. I believe the legislation designed to make it mandatory for provident fund members to buy an annuity if their benefit exceeds this threshold has been postponed to 2018. But the fund manager told me that I can take only one-third tax-free and must buy an annuity with the balance. Is this correct?
Daniel Rossouw
Marius Cornelissen, a financial adviser at PSG Wealth in Menlyn, Pretoria, responds: Legislation allows you, at retirement, to withdraw the full value from your preservation provident fund as a lump sum. This lump sum is taxed according to the retirement lump-sum or severance benefits table. The minimum age at which you are eligible to retire from a preservation fund is 55.
If the value of your pension, provident, preservation or retirement annuity (RA) fund is below R247 500 at retirement, you are allowed to commute the entire amount as a lump sum. The amount is also taxed at the rates in the retirement lump-sum benefits table.
If you are invested in a pension preservation fund or an RA fund, you are allowed to withdraw up to one-third of the amount as a cash lump sum and you must buy a guaranteed or living annuity with the remainder, unless the amount is less than R247 500. If it is, you can withdraw the entire amount, which will be taxed according to the retirement lump-sum benefits table.
TAX ON FOREIGN INTEREST, INCOME
If I want to invest an amount of money in an offshore bank account, must I pay a percentage of that money as tax to the South African Revenue Service (SARS) and also declare any interest to SARS and pay tax on it? Do I have to register as a taxpayer in the country where the bank account is domiciled and pay tax on the interest to the receiver of revenue there? If I am contracted to work in a foreign country, and my salary is paid into a bank account in my name in that country, must I declare that income to SARS and pay tax both to SARS and that country’s receiver of revenue?
James Moriarty
Graham Lovely, a financial adviser at PSG Wealth in Rondebosch, Cape Town, responds: You may take your money offshore as part of your R10-million annual offshore allowance, which requires a tax clearance certificate from SARS, or you can take up to R1 million offshore a year without the need for tax clearance from SARS. You do not need to pay a percentage of that money as tax to SARS.
You will, however, have to declare the interest on your offshore bank account to SARS. With effect from the tax years starting on or after March 1, 2001, South Africa moved from a source-based to a residence-based system of taxation. This means that all the income of a person who is resident in South Africa, no matter where in the world he or she earns that income, is subject to tax in this country, subject to certain exclusions.
To eliminate double taxation, certain countries have agreements that normally provide that income of a certain nature will be taxed only in one of the two countries, or may be taxed in both countries and the country of residence will allow a credit for the tax that has been imposed by the country where the income was earned.
If a country taxes on the source basis and the country of residence also taxes the income, it is for the country of residence to give relief, usually by a credit for foreign tax or an exemption.
Applying this to your circumstances, the foreign interest received by or accrued to you, as a resident, will be subject to normal tax in South Africa. The funds held in an offshore bank account will probably be subject to a withholding tax, which means the foreign country taxes at source. However, you do not have to register as a taxpayer in that country in order to claim back the tax. Foreign taxes paid by residents are allowed as a credit against their South African tax liability, so you shouldn’t be taxed on the same income twice. Most double-taxation agreements (DTAs) limit source tax to 10 percent of gross interest.
In summary, you could pay tax of up to 10 percent on the interest in the source country, but you will be able to offset it against the tax levied on the foreign interest in South Africa via a tax credit.
South African-resident employees who render services for an employer outside South Africa for a period which in aggregate exceeds 183 full days commencing or ending during any period of assessment, and for a continuous period exceeding 60 full days during that 183-day period, will not be liable for South African income tax on their remuneration for that period. If, however, your contract does not allow you to meet the criteria for exemption, you could be double taxed, because you could be taxed in the country of residence and in the country where the income was earned.
Most countries impose tax on the worldwide income earned by a resident of that country and on income earned by non-residents on locally earned income.
South Africa has agreements with a number of countries to prevent the double taxation of income. You may have to refer to the DTA with the country where you are working, or consult a tax expert to help you to avoid double taxation.