(Illustration: Vecteezy) Question: I am 30 years old and earn R 20,000 a month. I have no savings whatsoever and want to start putting some money away for my retirement. How do I go about doing this?
Answer: There are two investment vehicles that are worth considering: a retirement annuity and a tax-free savings account (TFSA).
Retirement annuity
A retirement annuity is a long-term investment that is designed to provide you with an income when you retire. Positive features include that premiums are tax-deductible and growth is tax-free.
Your contributions are tax-deductible within certain limits. In your case, if you invest R2,000 a month in a retirement annuity, you will get a monthly tax break of around R380. This is the equivalent of an immediate return of 19%. The growth inside the retirement annuity does not attract any tax.
However, there are negatives. You cannot easily access the funds in your retirement annuity before you turn 55. If you make a withdrawal from the fund under the new two-pot system, the withdrawal amount will be taxed at your marginal rate.
At least two-thirds of the investment value of your retirement annuity must be used to purchase a pension for yourself when you retire. This income will be taxed as per the normal income tax tables.
Investments into a retirement annuity are governed by regulation 28. This limits the amount that you can have in equities or offshore. There may be times when you would be able to get a much better return by not being constrained by these regulations.
Tax-free savings account
You can use a TFSA very effectively to provide a retirement income. You are allowed to invest a maximum of R36,000 a year into a TFSA with a lifetime contribution maximum of R500,000. If you invest more than those amounts, you will pay 40% tax on the additional amount you invested.
On the positive side, we have tax-free growth, and no limits on where you invest your money. The growth within the investment is tax-free and any withdrawals you make from it will not attract any form of tax.
Unlike a retirement annuity, you can invest 100% of your funds in equities. I often do this with young investors as they have time on their side and can be in a very aggressive portfolio that should provide a better level of growth over the longer term.
The withdrawals that you make from this investment will not attract income tax. This can be an extremely useful tool when it comes to managing your income tax-efficiently when you retire.
If you do have an emergency and want to use the funds, you can gain access to them immediately. This can be a negative if the intention is to grow the funds for your retirement as you will be losing all the potential compounded tax-free growth. Also, you may only ever invest R500,000 in this type of investment.
Both these investments can do the job for you. The RA will give you an immediate tax break but will limit the investment options and you will pay tax on the income. The TFSA will give you no tax break on your premiums but you can invest in an unconstrained way and the income you receive will be tax-free. DM
Kenny Meiring is an independent financial adviser. Contact him on 082 856 0348 or at financialwellnesscoach.co.za. Send your questions to kenny.meiring@sfpadvice.co.za.
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