Question

I own a small business and am concerned that a number of my older employees have not made any provision for their retirement. I would like to assist them in this regard. I want to give them an ad hoc salary increase, with the proviso that they pay this money into a retirement annuity. I do not want the schlep of setting up a pension fund. Would this work? Will there be any unintended consequences?

Answer

You are doing a good thing. Too few people make provision for their retirement until it is too late.

I would, however, recommend that instead of paying them the money and having the debit orders come off their personal bank accounts, you pay the premiums directly from the company bank account. This would remove the temptation for your employees to use this money for short-term expenses rather than for their retirement, as intended. One of the most important principles for building up wealth is to invest before you spend. If you want to save money, put the money into your investment before you spend rather than go with the principle of investing what is left at the end of the month.

People who work for large companies with pension funds typically have this situation. The money they receive in the bank each month is what is left after the deductions for their pension have been made. Sadly, the converse is probably why people who work for themselves or for small companies often find themselves with inadequate retirement savings.

The product you need is called a group retirement annuity. The individual member takes out the policy in their own name, but the company pays the premium. Should the employee ever leave the employer, the policy will continue in that individual’s name and he or she could continue to pay the premiums themselves.

Should they not be in a position to continue with the premiums, the policy can be made paid-up. The individual would only be able to access that money when he or she turns 55. This is a very simple way of achieving the desired result.

Tax implications

You need to be aware of tax. As you will be increasing their salary, they will be paying tax on this money.

As long as this increase is less than 27.5%, there shouldn’t be a problem. As they are not currently contributing to any retirement vehicle, the full premium will be tax-deductible. Your employees will not see any impact on their take-home pay, but they will be in a much better position when they retire. This is certainly something that small-business owners should consider doing for their staff.

Question:

You recently gave an example of a 79-year-old man investing R1,000,000 and getting R12,500 a month for the rest of his life. You also showed an alternative where he gets R7,200 a month and has the R1,000,000 paid to his beneficiaries when he dies. I am 65. What would these numbers look like for me and how would the tax work?

Answer:

Because these annuities are paid for the rest of your life, the size of the annuity will depend on how old you are. On average, a 65-year-old would receive a lot more payments than a 79-year-old, so it makes sense that the initial payment would be smaller.

The monthly annuity for the 65-year-old was R9,200, which, as we expected, is lower than the R12,500 that the 79-year-old would have received.

If you want to go the route of getting the R1,000,000 paid to your dependants when you die, then the monthly annuity would be R7,500 a month for the rest of your life, which is slightly better than what a 79-year-old would get.

In terms of tax, voluntary life annuities have some nice features. A portion of your annuity is classed as a capital repayment and is not taxable. The South African Revenue Service has a special formula that it uses for this.

In the example above, R3,400 of the R9,200 pension would be tax-free, so only R5,800 would be taxable. This is a lot more attractive than many interest-bearing investments, where only R34,500 is tax-free for someone over 65. (If you are younger than 65 the limit is R23,800).

In the second example where the R1,000,000 is paid out to your beneficiaries, the R1,000,000 would be tax-free, as it is classed as a life-insurance payout.