18 April 2016
To date, high earners enjoyed total tax deductibility on their contributions to a retirement fund. From 1 March 2016, Government will only allow tax deductions up to a maximum contribution rate of 27,5% or Rand cap of R350 000 per annum.
The question is, how tax and cost efficient is a non-deductible retirement fund contribution and how will it compare with the alternatives available.
Consider a member who makes an ongoing contribution of R10 000 pm to a retirement fund in addition to the maximum tax allowed R350 000 contribution in a year. The payroll will continue to transfer the full contribution to the fund and deduct the tax from the member’s cash remuneration. For the purposes of doing a comparison, we will assume that the amount invested is the net after tax amount. The investment returns in the fund will be tax-free. Upon retirement the lump sum benefit less un-deducted contributions are taxed at 36% (we assume that the member will in any event withdraw an amount of R1.050 million which means that any additional lump sum will be taxed at 36%).
This is then compared with a direct investment in a collective investment scheme. In the collective investment example we also assume that the amount invested will be net of tax. The investment returns however are subject to dividend, interest and capital gains tax. Any pay out at the end of the investment period will be tax-free. We assume a similar investment in both vehicles providing a return of CPI + 5%. We assume a higher cost structure in the collective investment and have therefore reduced the return by 1.5%. This amount can be bigger or smaller depending on the circumstances.
In the table below we compare the projected net proceeds of the two vehicles over a 5 to 30 year period.
The collective investment provides a slightly better net return over the 5 to 10 year period. Over longer periods the non-deductible retirement fund contribution provides a better return. Over 20 years it is 6.3% better and over a 30 year period it is 21.1% better.
This example can be considered a worst case scenario. If the member purchases an annuity the amount will not be subject to the 36% tax and the annuity payable will be tax free up to the amount of the un-deductible contributions made (they will not be inflation adjusted).
The comparison on its own may not convince members to elect one or the other option. Many members may prefer to continue to make contribution to the fund on account of -
Other members may lean in the opposite direction in view of the following considerations:
As benefit consultants we encourage funds to amend their rules to allow members to limit their contributions to R350 000. Based on the results of the worst case comparison though, members need not be in any rush to limit their retirement fund contributions.