Retirement Annuity – A Guide to the Ultimate Tax Saver

Get a retirement annuity and save tax!
Is this how you imagine your retirement..?

My guess is that most of you have heard of a retirement annuity before today. But do you really know what it is? Isn’t it just a fancy word for “pension”? Until fairly recently, I didn’t have a clue about how or what such an annuity works! But once I started learning of all the benefits that come with such an investment, I had to take out a retirement annuity right away! So if you are serious about saving up for the future, you should keep on reading. In this article, I will briefly outline the difference between a pension and a retirement annuity, after which we will take a look at the benefits of taking out an annuity.

Pension vs. Retirement Annuity

The Pension

A pension fund is something that every employee should have. By law, companies in South Africa have to pay a retirement fund contribution onto your pension fund. If your employer does not do that, he or she is committing a crime and you should report him/her. As an employee, you can also contribute to your own pension fund. It is not uncommon for employers and employees to contribute the same percentage of a salary towards a pension fund. For instance, your employer can pay 5% of your salary into your pension fund and you can meet him/her by doing the same. The money contributed towards your pension is not taxable, as long as the amount adds up to less than 27.5% of your earning, or R350,000. Depending on which amount is the biggest. So tax only gets deducted from your salary after you and your boss contributed towards your pension.

Depending on which pension option you take, you can either receive a lump sum of payout when you retire. Otherwise you can get a set amount of money each month, like a salary of sorts.

The Retirement Annuity

Now, a retirement annuity is similar to a pension, but it is not quite the same. You see, you have to pay for your own retirement annuity. Normally retirement annuities are sold by financial institutions such as Sanlam, PSG Wealth etc. These annuities are basically long term investments that you make. Because you cannot access that money before you reach 55 or more. After 55, the age depends on the company you buy your annuity from, but the fact remains that you can’t buy a retirement annuity at 30 and then want to withdraw that money at 35. Much like a pension, which only becomes available to you after you’ve reached your retirement age.

Once you reach the age where you can access the money from your annuity, depending on which annuity you took out, you will get a lump sum payout of one-third of the total worth of the annuity. And then after that, you will get a monthly payout, once again, like a salary.

Tax Benefits of an Annuity

By saving tax, your retirement fund will grow even more.

The cool thing about a retirement annuity is that it, like a pension, is also tax deductible! But before I cause confusion, let me just clarify that such an annuity does not serve as a replacement for your pension. It is supplemental to your pension! Anyhow, where was I..? Oh yes, you pay for your own retirement annuity. What this means is that you will have slightly less spending money each month. But by living on a tighter budget for the rest of your career, you can live with a lot more money after you’ve retired.

While You Invest

Typically if you invest in a share on the JSE, you invest money after income tax has been deducted from your salary. Plus, when you convert those shares to money ten or twenty years from now, that money is once again taxable. That is if you made a profit on the stock you sold. On the other hand, if you invest in a retirement annuity, you can get tax back on the money you pay for your investment each month. You can either pay the annuity before tax deductions (if you work for yourself or do your own tax) or claim it back from SARS when the time comes.

The difference between buying shares or stock in a company and a retirement annuity is that you can only spend a certain amount of money on the annuity each month, whereas you can spend as much as you want on the company shares. But, you won’t be taxed on the growth of your annuity, whereas you can be taxed for the growth on your other investments.

When You Get Your First Payout

Once you’ve reached 55, you can start getting paybacks from the annuity. The first R500,000 is not taxable, but after that, you will start paying tax on the remaining income that you generate from the annuity. However, the tax that you pay on the remainder of the annuity starts at 18%. Add to that the fact that you got half a million without having to pay tax on it, you get a massive tax saving of up to 22%.

And After…

This may be a bit morbid, but when you die, the remaining investment value of your retirement annuity is not added to your estate duty tax. That means that those people that depend on you for their life support will inherit more money fro you. As I said, it is a tad morbid, but all of us will die one day… Don’t you want to be able to give that little bit extra to your family and dependents, even after you are gone?

And there you have it!

There you go folks! I hope that my brief explanation on how to save on tax by investing in a retirement annuity made sense to you. If it did not, here is an example of how it works:

Let’s say you earn R600,000 per annum (before tax). Between yourself and your employer, you contribute 10% of that income towards your pension. You now sit on R540,000 taxable income per annum. If you invest in something other than a retirement annuity, you will pay roughly R140,000 in tax. But let’s say you spend R100,000 on a retirement annuity every year. Your taxable income is now R440,000, meaning that you will pay roughly R35,000 less in tax. Sure, if you don’t invest in such an annuity and you don’t invest in anything else, you will have R60,000 more to spend every year. But where will that leave you in the future?

So are you thinking what I’m thinking? Time to invest in a retirement annuity! The choice is up to you.