Tax Free vs RA (Retirement Annuity); these two investment options are excellent for long term savings.
There is a strong argument that every investor should have a tax-free investment and a retirement annuity but what if you have to choose one?
Which one is best suited for you? There are financial products available specifically for retirement but do they really benefit you?
Do they help you achieve your financial goals?
In this article we are going to dive into Retirement Annuities and Tax Free Investments to see which is best suited for you.
What is a Retirement Annuity?
A retirement annuity is an extremely tax efficient way to save for retirement. They are attractive because of the significant tax deduction.
Also, the money you put into an RA is deductible from your taxable income.
For example, if you earn R300 000 in a year and you contribute R36 000 in that year or R3 000pm. Then you are only taxed on R264 000. Which is the difference between your taxable income and your retirement annuity contributions. This reduces your marginal tax rate.
In fact, the tax benefits are so great there needs to limits imposed on contributions and rebates. If you exceed the contribution limit for the year, the amount you over contributed will be carried over as a deduction to the following tax year.
What are Tax-Free Savings Investments?
A tax-free savings investment is an investment that grows without any tax. Ordinary investments will trigger capital gains tax, dividends and interest. A tax free, as the names suggests, has no tax.
There are limits to this investment. You are limited to contributions of R36 000 per tax year and a maximum total contribution of R500 000 in your life time.
The interest, capital gains and dividends earned are completely tax free. There is a penalty of 40% on the excess amount of the maximum contribution allowed.
For example, if you contributed R 40 000 in a tax year from your income, the 40% penalty will be on the R 4000 excess and the amount is payable to SARS.
It is wiser to have a Tax-Free Investment with one provider. Reason being that it is easier to manage your contributions.
Most providers reject additional contributions after you have reached the limit to avoid penalization.
You also cannot reinvest money that you have withdrawn from a tax free investment.
When the maximum lifetime contribution is reached, the money remains invested until you want to withdraw.
To give a clear idea:
If your investment grows by R 1 000 000 over 10 years, you would have made a capital gain of R1 000 000.
In an ordinary investment you would be liable for 40% CGT but with a tax-free investment that amount is paid to you tax free.
So which is better? Tax-free vs RA
The tax rebates on a retirement annuity are more advantageous as your taxable income after the contributions falls into a lower marginal tax rate.
With a Retirement Annuity there is the added advantage that it is protect as you can only access the funds after age 55.
If you only invest in a Tax-Free for retirement and you have no other investments you risk spending the money before retirement.
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