A reader asked: “I am 38 years old and I am not happy with the returns on my Retirement Annuity (RA). I am considering scaling down my monthly contributions and rather investing the money offshore myself through a stockbroker. What are the tax differences once I reach retirement? Would I pay more tax drawing down from a living annuity or would I pay more tax with a share account that I draw down to cover living expenses?”
It is important to understand why the returns on your retirement annuity have been so poor. It may be that the investment house has done poorly relative to other providers and you could improve the performance by switching to another investment house.
The main tax benefit of an RA is the upfront tax deduction. If you invested your tax rebate into your RA you would significantly boost your retirement fund. You pay less tax now and it grows tax free, but once you reach retirement you will have to buy an annuity and you will pay tax on the income you draw from the living annuity.
On the offshore share portfolio, you will not get the initial tax deduction on your income. You will also pay dividend tax on those offshore shares, even if you are re-investing the dividends. That means you will have to pay that tax each year from your local income.
When you come to withdraw funds from the share portfolio to cover living expenses, you would pay capital gains tax.
Make use of your tax-free allowance
The one way to reduce these taxes is to invest the first R3 000 a month into a tax-free investment account (TFI). You would have to invest in a rand-based fund (or funds), although you can choose an exchange-traded fund that tracks an offshore index or fund.
Retirement annuities, like all retirement funds, have significant estate-planning benefits. They do not form part of your estate so are exempt from executor fees. For example, if your share portfolio were worth R3 million, your estate would pay R120 000 in executor fees on the portfolio alone.
An RA is not added to your estate in terms of calculating estate duty. It does not use up your R3.5 million abatement from estate duty. Capital gains tax on death does not apply either.
Retirement funds are taxed on death, but the tax falls under the retirement tax tables, where the first R500 000 is tax free and then a sliding scale is applied.
Also keep in mind that estate planning for offshore investments can get complicated as probate and even death taxes could apply in the jurisdiction where the investment is held, and you would need to have a will in that jurisdiction.
This article first appeared in City Press.