What are your Options as a South African?
Getting older does not have to be intimidating. Just by spending a little more time on planning and making a few smart decisions today, could mean the difference between a comfortable or tricky transition into your Golden Years.
And the good news is, you don’t have to be a financial genius to do so! In this blog we break down the options available in South Africa and offer some tips and tricks for the ‘Ouma’ or ‘Oupa’ experience of your dreams.
Why don’t more people save for retirement?
Behavioural psychology has shown that people struggle to make rational decisions that will benefit them in the long term because of the initial trade-off. This is made more obvious by a Sanlam Benchmark Symposium survey that showed that 51% of retirees can’t make ends meet.
Whatever the reason, this reluctance to save for the future means most people experience a major reduction of standard in living when they retire.
Because of the burden this tends to have on the government, you are immediately rewarded from a tax perspective when it comes to retirement saving.
You essentially have two options when it comes to saving for your old-age, these are:
Option 1 . Pension Fund or Provident Fund
We have grouped these together because the main distinctions between these two have mostly fallen away. Both a Pension Fund and a Provident Fund are dependent on being employed, and these packages would form part of your company benefits. Depending on the company the specifics of the packages look, the amount you contribute, the amount you get out will differ. The defining qualities between a Pension Fund and a Provident Fund has been their individual pay-out structure.
Historical difference between Pension Fund and Provident Fund
With a pension traditionally one has been able to withdraw only ⅓ upon arrival at the doors of retirement, and then ⅔ one would be used to purchase a regular income retirement annuity. This was unlike the provident fund which allowed you to withdraw the entire sum at retirement/resignation and there was no obligation to purchase an annuity.
The Dissolving of the Difference Between Pension and Provident Funds
Recent regulations have made the two almost indistinguishable. Members of a provident can now take a ⅓ as a lump sum and must use the rest to purchase an annuity. An Annuity will provide you with an income and there are 2 types of annuities:
1. Living Annuities are flexible and the member can choose their withdrawal rate (2,5%-17,5%). The member can choose the funds they want to invest in. This investment provides flexibility, but you run the risk of running out of capital. If you die before you run out, your heir/s will receive the remaining funds.
2. A Life Annuity offers guaranteed income escalating annually at your chosen rate. The investor does not choose funds. They agree on a fixed return rate when purchasing this annuity. This generally provides more certainty. However, when you pass away, you cannot leave an inheritance. Therefore, the insurer runs the risk of you outliving your capital.
You can use the ⅔ to purchase a combination of the 2 Annuities above. For example, some clients purchase a Life Annuity to cover their fixed living cost, and use the remaining funds to purchase a Living Annuity.
However, most investors do not have enough capital to be able to live off the income from a Life Annuity. They are forced to take their chances with a Living Annuity and hope that the funds they choose outperform the returns offered by the Life Annuity.
If you were to move to a new company before retirement age, you can transfer the funds to a new company’s fund, a preservation fund, or a retirement annuity fund, with tax considerations for cash pay-outs. Remember, any withdrawals will trigger tax, but transfers are free of tax.
Option 2. Retirement Annuity (RA)
Sadly, it is a fact that most people’s pension will simply be inadequate. This means, many with a pension might also consider taking out a Retirement Annuity.
A Retirement Annuity is a tax-advantaged investment where individuals make regular contributions. This is different from a pension because it is personally managed, which allows for more flexibility in investment choices. It is also not necessarily linked to employer-sponsored plans.
Retirement annuities put you in the driver’s seat more. Being non-employer dependent, things like a change in job become irrelevant. You choose funds for investment within certain regulated limits. This means that when you move past 55 years old, you can access ⅓ of the funds lump sum as a taxable lump sum. Then, like the other options, the remaining ⅔ must be used to purchase an annuity, which will also be taxed. If your total falls below R247 500, you can withdraw the full amount subject to tax. You can also increase/decrease (even pause) your contributions at any time – a benefit not necessarily there with a pension fund or a provident fund.
However, take caution: the fact that a Retirement Annuity is personally managed means it can also be poorly managed. Do not make the mistake of under contributing. Another mistake would be investing too conservatively. You should view your Retirement Annuity as a long term investment that gives you the opportunity to have a more diverse risk portfolio.
The argument for Retirement Annuity
Retirement options are becoming less binary – there is a lot more flexibility. As mentioned before most people’s traditional pension-type retirement savings are insufficient. There is a strong argument for having both, creating a larger retirement savings pool.
Take home point
The above should give you a good idea of the different options for saving for your old age. As you can see, being complacent about your retirement can leave you in a sticky situation. On that same note, there are things you can do to make it possible for your retirement years to be a lot easier. This includes making sure you are contributing the right amount, and perhaps have dual savings instruments. For example, having both a pension and a retirement annuity. You can learn more about how best to approach saving for retirement in our past blog article here.
Now that you have a good idea of what the main future savings vehicles are, we will unpack some of the latest updates to legislation that affect these types of savings that you should also be aware of.
The below answers the questions “How does this relate to my Tax?” and summarises some updates to legislation that are important to take note of.
Tax and Retirement Annuities
Retirement Annuities can be a financially savvy tax approach to future savings. For one, individuals can deduct retirement contributions of up to 27,5% of their taxable income/remuneration, limited to R 350 000 per year.
For example, if someone earns R 480 000 p.a. (R 40 000pm), they can contribute up to R 132 000 p.a. (R 11 000pm) and the full contribution will be tax deductible.
It is not always feasible from a cash flow perspective to contribute the full 27,5% on a monthly basis. This is why we recommend our clients to top-ups during the year whenever they receive additional income, commission or bonuses.
Furthermore, even if you were able to add more to your retirement annuity in a given year (which you are incentivised to do) and it exceeded the cap of R350 000 that year, this excess could fall into the next financial year. It is also worth noting that, during the years before retirement, the annuity enjoys tax free growth. This can reap potentially bigger overall returns at the time of retirement.
Finally, in the event of bankruptcy, the ‘boogie man’ in the room, the cash benefits from a retirement annuity are not included in the estate. In the context of bankruptcy, assets included in the estate may be used to settle debts, but since retirement annuity benefits are excluded, they may be safeguarded for the individual and their family.
Recent Legislation: The Two Pot System (starts 1 March 2024)
Image Source: ‘Old Mutual, South Africa’s Two Pot System’
Keeping up-to-date, South Africa’s Two Pot System is important to be aware of regarding future savings and tax. This is the government’s attempts to try and improve members “retirement outcomes’”, by trying to offer a safety net of short-term financial relief in emergencies whilst safeguarding longer term financial security.
Financial hardships are present the world over, but particularly present in a South African setting. The two-pot (misnomer: actually three pots) system being introduced gives you controlled access to your retirement funds during such times prior to retirement.
How will this work?
The contributions you have been making toward the future will be divided up into three pots/components with different rules around when you can access them.
POT 1: Vested component. Composed of the previous accumulated retirement fund that you are entitled to up until 31st August 2024. However, seed capital (10% of POT once-off valued on August 31st 2024) for your second pot (savings) will be taken from this pot.
- For example: If you saved R 100,000 by August 31st, 2024. R 10,000 will be taken as seed money for the next pot (POT 2).
POT 2: Savings component. This pot will receive ⅓ of your retirement savings starting on 1st March 2024. Able to be withdrawn and added to taxable income prior to retirement.
- For example: If you have R 60,000 in savings, R 20,000 will be in POT 2. You can withdraw from this pot before retirement, but it will be taxable.
POT 3: Retirement component. This pot will receive ⅔ of your retirement savings starting on 1st March 2024.
- For example: Using the same R 60,000 example, R 40,000 will be in POT 3. This pot is only for retirement and can’t be accessed until then.
What happens in the case of retirement/retrenchment and the two pot system?
Unlike previous years, in this scenario you cannot withdraw all your retirement funds without reinvesting into another future income vehicle (different kinds). Pension/provident funds will be able to withdraw all vested components as well as all savings components, while in the case of retirement annuities only the latter will apply.
As retirement savings is an age specific thing, how does my current age factor for this new legislation?
If you were 55 or older on the 31st March 2021, you will be presented with two options. Keep contributing to the vested component until you cash-out and retire, or start the two-pot system.
In Conclusion: The Reality
“Only 36% of South Africans have a retirement fund, and only 7% of retirees feel well prepared for it – survey” (News 24)
How well you live out your retirement is not as straightforward as contributing to your work’s pension and assuming it will equate one day to a smooth transition into your non-working years.
Ninety-six percent of South Africans will need to scale back their lifestyles in their old age, with some facing discomfort to the extent that essential needs, such as medical costs, become challenging to cover. For most, the amount you are contributing to a pension is not likely to cover you for your retirement.
When making decisions about planning for retirement, the following factors need to be considered: How long have you been contributing to your future savings? What percent of your salary? What will your monthly expenses be at retirement – for instance, do you own your property? And a big one, are you living within your means?
Remember, regardless of your wealth level, if you are not doing these things right you could come out short; most are simply not contributing enough. Another factor to take into account is that people are living longer due to medical innovations – this means your capital needs to last longer and you will need to save more than what your parents needed to save.
Traditionally people followed a rule of thumb of saving 15% of their salary for retirement. Most corporations still follow this model – 7,5% Employee Contribution & 7,5% Employer Contribution. However, it is important to note that if you start later you need to increase your contribution to 20% or more.
Hopefully this blog article sheds some light on your options, and don’t forget to get in touch with TVC Wealth and Health Managers for a tailored savings plan just for you!
ENDS
Contact TVC Wealth and Health Managers for advice today for personalised advice. We can advise you on how best to invest your money, run through the numbers with you, and match your financial goals with your lifestyle.
References
News24. (2023, February 8). Only 36% of South Africans have a retirement fund, and only 7% of retirees feel well-prepared for it – survey. Retrieved from https://www.news24.com/fin24/partnercontent/only-36-of-south-africans-have-a-retirement-fund-and-only-7-of-retirees-feel-well-prepared-for-it-survey-20230208 \
Sanlam. (2023). Retirement Benchmark Survey 2023: Insights. Retrieved from https://www.sanlam.co.za/corporate/retirement/benchmarksurvey/Documents/Benchmark%202023_Insights.pdf