When deciding on what types of financial products to use to provide an income in retirement, you need to take tax into account, although it probably won’t be the primary deciding factor.
In this column, I break down the taxes on various income-generating products or investments. You would need to delve into the tax consequences in more depth with a financial adviser or tax practitioner to work out the most tax-efficient route for you, but this should give you an overall picture.
Tax basics for retirees
Before looking at specific product types, here are some basics:
• At retirement, you can take up to one-third of your accumulated retirement fund savings as a lump sum, of which R550 000 is tax-free. The remainder of the lump sum is taxed according to the SA Revenue Service’s retirement lump-sum benefits tax table.
• The remaining two-thirds (or more) of your savings, which is not taxed, must be used to buy a pension in the form of a compulsory purchase annuity, of which the main two types are living and life annuities (see my column from last week, “The mind-boggling task of choosing an annuity”).
• You are subject to tax on your income, which may be from annuities and other sources, if it exceeds the tax threshold of R148 217 for people aged 65 to 74 years or R165 689 for people of 75 and older (2023/24 tax tables). These are based on the higher rebates for older people (R26 679 and R29 824 respectively).
• There are exemptions on interest from a South African source of R23 800 a year for people under 65 years of age and R34 500 a year for people of 65 and older.
• If you’re 65 or older, you receive higher concessions on medical expenses in the form of tax credits – see the “Medical Credits” section on the South African Revenue Services (Sars) website.
• You will need to register as a provisional taxpayer if you have multiple sources of income, subject to certain thresholds.
Compulsory purchase annuity
This is an annuity you buy with two-thirds or more of your retirement savings that you do not take as a lump sum. It may be a life annuity, a living annuity, or a hybrid of these two basic types. Because you did not pay tax on your retirement fund contributions while saving, you do pay tax on the income you receive, according to the Sars income tax tables, and this is deducted by the annuity provider in the form of PAYE (Pay As You Earn). However, as in a retirement fund, the underlying investments are not taxed (no tax on interest, dividends, or capital gains).
Voluntary purchase annuity
This is an annuity you can buy with discretionary savings. It must be a type of life annuity offered by a life insurance company, not a living annuity offered by an asset manager. Because the product is bought with after-tax savings, only the interest portion of the monthly annuity payment (rather than the entire annuity) is taxable in your hands. (Sars has a formula for determining the interest portion.)
Any taxable income from discretionary investments must be declared in your annual tax return, which may be pre-populated with figures from providers. Investments include:
• Unit trusts and exchange-traded funds: these are subject to the regular taxes on investments – on interest (in your hands, subject to exemptions), dividends (20% withheld), and CGT on gains when they are realised (when you sell units or switch funds), subject to exemptions and thresholds.
• RSA Retail Bonds: you pay tax on interest in your hands, subject to exemptions, whether you receive it as income or it is retained in the product. This means that in an inflation-linked bond, you pay tax on your income plus the inflation-linked amount by which your capital increases. There is no CGT or dividends tax in this or other interest-bearing investments.
• Bank deposits: you pay tax on interest in your hands, subject to exemptions.
• Share portfolios: you indirectly pay the 20% tax on share dividends and you pay CGT on gains made when you sell shares. Realised losses may be deducted from realised gains or rolled over to the following tax year. If you are buying and selling shares regularly, Sars may regard you as a trader, in which case gains are taxed as income.
• Endowment policies: the underlying investments are taxed in the hands of the provider, so you do not pay tax on what you receive.
• Property: if you have a physical property from which you are receiving a rental income, you are taxed on that income after deducting expenses. You pay CGT on gains made when selling the property, subject to thresholds and exemptions.
* Hesse is the former editor of Personal Finance.