Illustration: Colin Daniel

Do not simultaneously halt your retirement annuity (RA) fund contributions and increase your contributions to your occupational retirement fund as a consequence of the new retirement fund tax regime before doing your homework.

The increase in the permissible percentage of your contributions of your pensionable income that you can deduct from your taxable income from March 1 means that you need to do some calculations and make some decisions, particularly if you are a member of an occupational retirement fund.

The increased deduction limits below the new rand limits on contributions mean that most income earners will be able to increase their monthly contributions significantly above their current contributions.

If you are a member of an occupational fund, you may find, however, that there may be no further need to contribute to a RA fund, because you can cost-effectively put all your contributions into your occupational fund.

However, there are few things you should consider before you ditch your RA fund for future contributions. These include:

* Defined-benefit funds. If you are a member of a defined benefit retirement fund, it is very unlikely that you will be able to increase your contributions, because your pension at retirement is guaranteed based on a formula that includes your contributions being fixed at a certain percentage of your income. An RA is the way to go for additional savings up to the new limits.

* Fund-provided pension. If you belong to a retirement fund that provides you with a pension, you may wish to keep your additional savings out of the fund for three reasons, namely:

- You can keep an RA open, even when not contributing, well past the date you retire from your occupational fund. There is no forced age limit on maturing an RA. This means you can use the money to top up your pension and counter the effects of inflation later in your retirement.

- When you receive a fund pension, the pension will stop when you die or when your partner dies. This has two consequences, namely: the spouse’s pension is normally a percentage (between half and two thirds) of your pension, and there is no money available for your heirs. By using an RA for your extra savings you can provide a top pension for your partner, and your dependants can be nominated as beneficiaries if you die while the RA is in force; or the pension proceeds can be passed on to them if you buy an investment-linked living annuity (pension) with the proceeds.

- Estate planning (see below).

* Contractual commitments. If you have a life assurance RA, it will probably have contractual contribution terms. If you make your RA “paid up” and you do not meet these commitments, you could be subject to a penalty. The penalties can be up to 30 percent of accumulated savings on RAs sold before January 1, 2009; and 15 percent reducing on a sliding scale on those sold after January 1, 2009.

If you do make an RA “paid up”, the money must remain invested until you reach at least age 55 – the earliest date of retirement from an RA.

* Costs. The costs, particularly the asset management costs, of an occupational retirement fund are usually far lower than for a RA. This, however, is not necessarily always the case, particularly if you are a member of an umbrella fund sponsored by the financial services industry. High costs mean lower end benefits.

* Investment performance. Most segregated occupational retirement funds offer their members limited investment choice – mainly restricted to balanced funds that invest across all asset classes. You receive wider choice in most cases if you are a member of an umbrella retirement fund. If you do not have wide choice you may feel, particularly when you are younger, that you want a more aggressive investment portfolio than that offered by your fund. But you cannot risk all, because RA funds are governed by the prudential investment guidelines in regulation 28 of the Pension Funds Act, which, for example, limit investments in equities to 75 percent of your savings. While equities historically have provided the best performance of assets classes, they also come with the highest volatility (the propensity to gain and lose value) and therefore are more risky than other asset classes. However, the longer you remain invested, the less you are affected by volatility.

* Tax consequences. You can retire from an RA any time from the age of 55, which in itself may be useful, but when you retire you must use at least two-thirds of your accumulated savings to purchase a pension for life, which will be subject to income tax based on the marginal income tax tables. Any lump sum you commute will be subject to retirement fund lump-sum taxation.

* Tax planning in retirement. You can continue to contribute to an RA with all the tax benefits after you retire from an occupational retirement fund. You can reduce your taxable income by deducting the contributions to your RA from the pension bought with the savings of your occupational fund.

* Estate planning. RAs are useful tool for planning the distribution of your estate when your total assets exceed the various death duty taxes. When you die you are subject to:

- Estate duty, which is 20 percent of your net assets (assets less liabilities) less the abatement of R3.5 million.

- Capital gains tax (CGT), which is applied on the gain in capital value on most assets from the point of ownership to disposal or death. The effective rate of CGT, depending on your income tax rate, ranges from zero to a top rate of 13.3 percent if you are on the top marginal income tax rate of 40 percent.

The Estate Duty Act excludes retirement benefit lump sums and annuities from the estate of a deceased person. Any benefit taken by a beneficiary in the form of an annuity (a regular payment) will be added to the gross taxable income of the annuitant (beneficiary) and taxed as such as part of the annuitant’s (beneficiary’s) income. Any lump sum withdrawn by the beneficiary will be taxed in terms of the lump-sum scales for the retirement funds with the first R315 000.

(Note: No death taxes apply to assets bequeathed to a spouse.)

In other words, the beneficiary in effect becomes the new pensioner with all the tax advantages held by the initial RA member.