Tax-efficiency should be a key consideration in your retirement planning. Ideally, at each phase of the planning process – from when you begin working to when you retire and draw a pension – you should be as tax-efficient as possible.

This is the view of Jenny Gordon, head of retail legal support at Alexander Forbes, who spoke on tax issues at the recent Ready Set Retire conference.

There are many factors you need to think about when planning for retirement, Gordon says. These include inflation, your tolerance for risk, investment performance, your savings time horizon and tax-efficiency. “However,” she says, “paying less tax should not be a major goal in itself. It needs to rank together with all those other factors.”

In other words, to benefit most from your planning, you need to look at all the factors in conjunction with each other. “It’s really about sitting with your financial adviser and working out what is best for you,” Gordon says.

She outlines the tax efficiencies at each phase of the retirement planning process.

CONTRIBUTIONS

You can save for retirement in two ways: via retirement funds with pre-tax income and via discretionary investments with after-tax income.

Retirement funds are the primary way to save, Gordon says. Why? Because you get tax-deductibility at the outset on each of the three types of retirement funds: pension funds, provident funds and retirement annuity (RA) funds. This means more money in your savings earning returns.

“As individuals, we don’t get too many tax breaks these days. But the one break we do get is when we are saving for retirement, and it’s quite a nice break at that. With the new marginal tax rate that our Minister of Finance gave us on February 25, for every rand we put into retirement saving, the government subsidises up to 41 percent. And that’s not to be sneezed at.”

Currently, the tax treatment of each type of retirement fund differs. An employer’s contribution to a pension fund or a provident fund is not taxed as a fringe benefit for the employee, so there is a tax benefit there. Then, in a pension fund, the greater of 7.5 percent of retirement-funding income (see “Definitions”, below) or R1 750 is tax-deductible. Contributions you, as an employee, make to a provident fund are not tax-deductible. And on an RA, the greater of 15 percent of non-retirement-funding income, or R3 500 less current deductions to a pension fund, or R1 750 is tax-deductible.

This tax regime is set to change, probably on March 1 next year. The government wants to standardise or “harmonise” deductions across the three types of fund, Gordon says. The proposal is that you will be entitled to a deduction of 27.5 percent of your remuneration or taxable income, which will apply to all funds.

So if your employer pays towards your retirement fund contributions and in-fund group life and disability cover, this will be included in your income as a taxable fringe benefit, and the new, higher deduction will offset this fringe benefit.

Gordon says that, under the new provisions, there will be an annual cap of R350 000 on contributions that qualify for a tax deduction.

However, there are ways in which non-tax-deductible contributions can be “written-off” as deductions. An over-contribution can be carried forward and deducted in the following tax year if you contribute less than the maximum in that year, or you can carry forward all your over-contributions until you retire and either add them to your tax-free lump sum or write them off against your pension income.

If you save for retirement in a discretionary investment, such as a unit trust fund, or you have shares, or a fixed deposit at a bank, you do not enjoy any of these deductions on your contributions.

BUILD-UP

How is the growth on your savings taxed? There are four types of tax that apply to investments: income tax on interest, dividends tax, capital gains tax and estate duty. Retirement funds are exempt from all these, giving them a further advantage over discretionary savings vehicles.

You can now invest discretionary savings in a tax-free savings account that has the same benefits as a retirement fund in the build-up phase. However, retirement funds have an advantage over tax-free savings accounts, because your contributions are from pre-tax income. Contributions to the tax-free accounts are limited to R30 000 a year and R500 000 in a lifetime.

EXIT

Assuming you preserve your retirement savings when you change jobs by transferring them tax-free into a preservation fund, RA or your new employer’s retirement fund, you enjoy tax benefits when withdrawing a lump sum on retirement. (From a pension fund or RA, you may take up to one-third as a lump sum. You must buy a pension with the remainder.)

A tax table applies to your lump sum (see tables, via link below). “At retirement, you get the first R500 000 of your lump sum tax free. Then there is a tiered way in which the rest of your lump sum is taxed, to a maximum of 36 percent,” Gordon says.

RETIREMENT

On your pension, you pay income tax as you would as an employee, but your tax rate will be lower if your income is lower, and after the age of 65 you get more generous tax rebates and greater medical tax credit benefits than a person under 65. If you still have money in a retirement fund, such as an RA, you will continue to enjoy the benefits of tax-free growth and no tax on capital gains.

Since March 1, 2014, you can write off non-tax-deductible over-contributions to a retirement fund against your pension income.

DEATH

If you die while you are a contributing member of a retirement fund, anything in the fund is free of estate duty, and your dependants or beneficiaries may choose how they want to take their benefit, Gordon says. If the full amount is paid out as a lump sum, the tax is calculated as if the benefit had been paid to you immediately before death, which means the retirement lump-sum table for you will apply.

Alternatively, your beneficiaries may choose to convert the benefit into an income received in their own names (in other words, annuitise it), and they will pay tax on the annuity as their own income in the year in which they receive it. This also applies if you die while receiving a living annuity that has a remaining cash value.

If you are drawing a pension that is a guaranteed annuity, nothing falls to your estate, Gordon says. If there is a minimum guarantee period and you die within that period, the income will be paid to the beneficiaries or the joint annuity holder and will be taxable as his or her income.

THE DANGERS OF NON-PRESERVATION

If you do not preserve your retirement savings when you change jobs, by withdrawing the money for immediate consumption, not only will it set you back in building up enough for a financially secure retirement, but you also pay more in tax.

Jenny Gordon says the tax laws are designed to encourage good behaviour in this regard and discourage you from squandering your savings. The tax table for lump-sum withdrawals on resignation is different from the one for lump sums on retirement (see tables, via link below). Instead of R500 000 being tax free, only the first R25 000 is tax free, and you reach the 36-percent maximum at R990 000 instead of R1 050 000. So on a cash withdrawal of R1 050 000, you will effectively pay almost R95 000 more tax, Gordon says. “Think carefully before you withdraw retirement savings,” she says.

DEFINITIONS

* Retirement-funding income: usually only your basic salary, which is used to calculate your retirement fund contributions.

* Non-retirement-funding income: what you earn above your basic salary, such as bonuses and travel allowances, which are excluded in the retirement-funding calculation. It may also be taxable income from your own business, investments, or rental income.

* Taxable income versus remuneration: for a salaried employee, these would be the same, but they might differ in the case of a small business owner, where some earnings might not fall under taxable income.

* Guaranteed annuity: a pension bought from a life assurance company, which guarantees you an income for life.

* Living annuity: a pension in which you have control over the underlying investments, and take the risk of running out of capital before you die.