How do we benefit from having a Retirement Annuity?

Retirement

“What’s the point of having a Retirement Annuity when I’m still relatively young?”

When we think of retirement annuities, we seem to forget that old age creeps up much quicker than anticipated, and the worst part is, once we realise we need to start saving, we are suddenly overwhelmed with a huge capital shortage.  Thousands of people are confronted with this problem on an annual basis.

“How am I supposed to benefit from something if I can’t even withdraw the full amount before a certain age?”

Well, there are many benefits attached to investing in a Retirement Annuity.

  • When you pass away, the retirement annuity is not included in your estate for estate duty purposes. 
  • Upon your death your loved ones, or chosen beneficiaries can withdraw the full fund value as a cash lump sum.  The lump sum will be tax deductible.
  • Your retirement annuity is protected against insolvency.  The same applies, should you be insolvent at the time of your death.  This means that your beneficiaries will be protected.
  • On retirement preferential tax tables apply to your lump sum benefit received
  • Should you own a retirement annuity you will be tax exempt from all returns achieved in the underlying fund.  This includes capital gains tax, income tax and dividends withholding tax.
  • You are even entitled to a tax deduction for any contributions made- up to 15% of taxable non-retirement funding income.  This is currently in addition to any tax deduction for pension fund contributions.

A retirement annuity can also be used as an estate planning tool for a suitable client

Estate planning is the process of anticipating and arranging for the disposal of an estate during your life. Estate planning typically attempts to eliminate uncertainties over the administration of a probate and maximize the value of the estate by reducing taxes and other expenses.

 

As an example to better understand this concept we will look at the following scenario:

Mr Sikhosana invests R5  000 000 (5 million) in a single premium retirement annuity.  He does not enjoy a tax deduction for the contribution made.

But, on his death, the fund value has increased to R5 750  000.  His beneficiaries elect to withdraw the full fund value as a lump sum.

So what happens now?

The fund value will be exempt from estate duty-thereby removing the R5 750 000 from Mr Sikhosana’s dutiable estate.  This is a potential estate duty saving of R1 150 000.

The lump sum is subject to income tax as if Mr Sikhosana received the lump sum.  Of the R5 750 000, the first R5 000 000 will be tax-free as this is the original contribution that did not qualify as a tax deduction.  Only R750 000 will be subject to income tax in terms of the retirement tax table.

Please note

This will not be successful where Mr Sikhosana requires the capital for retirement provisions during his lifetime, as only a third will be accessible as a lump sum during his lifetime.  He must be sure that his beneficiaries will in fact be entitled to the payout in the event of his death.  If the trustees find dependents entitled to payments, it can have undesirable consequences.

The essential elements of this structure are:

  • Section 3(2)(i) of the Estate Duty Act allows for an estate duty exemption of retirement annuity benefits.
  • The Income Tax Act defines a retirement annuity to allow for a full withdrawal on the death of a member.
  • The Second Schedule of the Income Tax Act determines that where the dependant or beneficiary withdraws a lump sum amount due to death of the member, that amount is taxed according to the deceased member’s retirement table.

 

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