Where to invest savings for optimal growth and tax efficiency

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By Danine van Zyl* 

Where to invest for retirement remains the top priority for most investors when they seek professional financial planning advice. The majority select a retirement annuity as the most logical option for their needs. However, this might not always be their best or only option.

Danine van Zyl

Saving for retirement through retirement annuities and preservation funds has always been widely recommended due to the tax benefits available. Investors are entitled to a tax deduction on their contributions of up to 27,5% of their taxable income or remuneration but limited to a maximum of R350 000. Growth on the investment is further free of any capital gains or dividend withholding tax implications – the objective being to encourage investors to save towards their retirement to avoid them from ultimately becoming dependent on government support. Controversial legislation, designed to protect investors, has however resulted in poor performance over many years and as an unintended consequence made the assets held by investors in these products vulnerable to governmental decision making. 

Regulation 28 of the Pension Funds Act prescribes and limits pension monies to 75% equity exposure, listed property to 25% and offshore exposure to 30%. This composition is generally reflected in balanced unit trust funds and has been a popular choice for pension monies where the asset manager ensures compliance with Regulation 28. Most of these funds hold around 40% in South African equities. The returns from the JSE have, however, been extremely poor by global comparison. The JSE All Share Index delivered 5.56% over the past 5 years which explains the poor average performance of Regulation 28 compliant balanced funds of only 6% over the same period. In strong contrast the S&P 500 and the MSCI World Index has delivered 14.25% and 11.33% respectively. 

The downside to investing in a product such as a Discretionary Investment which is not subject to Regulation 28 of the Pension Funds Act, is the liability towards interest, dividend and capital gains tax earned on the investment.

Let us compare the following scenario of a younger investor:

Investor 25 years of age wanting to retire at the age of 50 (25 years to retirement). 

Investment amount R100 000
Retirement Annuity growth rate 6%
Discretionary investment growth rate 12.79% (11.33% + 14.25%/2 as per paragraph 3 above)
Salary R450 000 (Marginal tax rate of 31%)
Inflation 4%

Capital at the end of the term:

Retirement Annuity Discretionary Investment
Initial amount invested R100 000 R100 000
Amount at 50 R429 187 R2 026 585
Growth  R329 187 R1 926 585
Tax saving R31 001
CGT payable R339 585
Capital at the age of 50 with tax break R360 188
Capital at 50 after CGT R1 687 000

The difference between investing in a Discretionary Investment which is not subject to Regulation 28 of the Pension Funds Act and investing in a Retirement Annuity is R1 326 812.

Let us compare the following scenario for an older investor:

Client 54 years of age wanting to retire at the age of 55 (1 years to retirement). 

Investment amount R220 000 (27.50% x R800 000)
Retirement Annuity growth rate 6%
Discretionary investment growth rate 12.79% (11.33% + 14.25%/2)
Salary R800 000 (Marginal tax rate of 41%)
Inflation 4%

Capital at the end of the term:

Retirement Annuity Discretionary Investment
Initial amount invested R220 000 R220 000
Amount at 55 R233 200 R248 138
Growth R13 200 R28 138
Tax saving R85 148
CGT payable R0 (R5064 before R40 000 annual exclusion per individual)
Capital at 55 with tax break R318 348
Capital at 55 after CGT N/A R248 138

The difference between investing in a Retirement Annuity at an older age and investing in a Discretionary Investment is R70 210 – making a Retirement Annuity the more attractive alternative.

Investors who are invested in a retirement product may retire from their investment from the age of 55 and transfer the proceeds to a Living Annuity. A Living Annuity is governed by the Income Tax Act, as such the restrictive provisions of Regulation 28 as contained in the Pension Fund Act is not applicable to these investment products – thus allowing investors to obtain up to 100% offshore exposure and generate similar levels of returns as possible in a Discretionary Investment.  

Conclusion:

Younger investors who invested in a Discretionary Investment would have received significant larger returns as compared to investors who invested in a Retirement Annuity for purposes of benefiting from the tax friendly nature and deductions on offer. 

An older investor who invested in a Retirement Annuity to receive the tax benefits on offer would have been better off as compared to an investor who invested in a Discretionary investment for the 1-year period. However, should the capital remain invested, the investor who invested in a Retirement Annuity will be able to retire from their Retirement product and transfer the capital to a Living Annuity to obtain similar levels of growth as compared to a Discretionary Investment. 

It should be noted that each investor has different needs, objectives, and risk profiles and as such the same advice will not always apply to everyone. It is advisable to always consult an accredited, qualified financial planner to devise a plan best suited to the investor’s personal circumstances and financial goals.

Read more about retirement planning.

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