JOHANNESBURG - The fact that a pension income is taxed has led some people to question whether saving in a retirement fund really is better than making your own retirement-savings arrangements using after-tax earnings, despite the tax benefits on contributions to retirement funds and the tax free-growth on savings within these funds. This is according to Andrew Davison, the head of advice at Old Mutual Corporate Consultants.

Davison said you need to consider a number of factors - not only tax - when evaluating your options.

“Taxation is an important factor, and it is useful to look at the full impact the various savings approaches could have on your take-home pay, as well as on your retirement benefit.”

He said one of the main ways the government encourages people to save for retirement is to offer tax deductions on savings in an approved retirement fund. Although this tax relief can be helpful when people are working and contributing to a retirement fund, the benefits they eventually receive from their retirement fund when they stop working are still taxed.

Davison said that to help South Africans make informed decisions about saving for retirement, Old Mutual Corporate Consultants conducted an investigation into how tax affects retirement outcomes.

The analysis aimed to compare how tax affected various vehicles to save for retirement, including a retirement fund, discretionary savings and a tax-free savings account (TFSA).

Davison said the analysis also considered different levels of income, because the impact of tax depends on how much a person earns.

The analysis was based on the impact of taxation over a person’s full working lifetime, as well as retirement, which meant assuming that the average person will start work at age 25, retire at 65 and live to 90.

“People who earn higher salaries pay more tax, which means the different tax treatment of the savings vehicles result in more significant impacts for higher-income earners,” said Davison.

He said the three levels of pre-tax income that were compared were R20000 a month, R60000 a month and R120000 a month.

Davison said the analysis showed that saving in a retirement fund results in the best outcome in terms of income after tax, both before retirement and during retirement. Based on the same level of take-home pay before retirement, a retirement fund provides an after-tax pension that is slightly more than double the income from discretionary savings.

By contrast, he said, the discretionary scenario provides the worst retirement outcome across all three income levels. “This is because the additional tax being paid on your salary, due to not benefiting from retirement contribution tax deductions, leaves relatively little money over to make a substantial post-tax contribution to discretionary retirement savings. The difference was more evident at higher income levels,” said Davison.

In the case of a person earning a gross salary of R60000 a month, a retirement fund provides an after-tax pension that is 75percent higher than discretionary savings, he said.

“Introducing a TFSA does improve the outcomes of both the discretionary TFSA and the retirement plus TFSA, but they still fall short of the retirement scenario. This is because TFSAs only provide tax relief on growth and there are limits on contributions, so the benefit is limited,” said Davison.

He said that across all income levels, the retirement scenario produces a net replacement ratio of about 100percent, based on savings of 15percent of salary, a 40-year working career and 25 years in retirement.

“This demonstrates that a suitable and diligent long-term savings plan can deliver a sound retirement outcome. That said, taxation is an important factor, and it is useful to look at the full impact the various savings approaches could have on your current take-home pay, as well as on your retirement benefit one day,” said Davison. 

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