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 investment.  Both have their pros and cons.

Retirement Annuity

A retirement annuity is a long term investment that is designed to provide you with an income when you retire.  It has several positive features:

• The Premiums are tax-deductible

Your contributions are tax deductible within certain limits.  In your case, if you invest R 2000 a month into a retirement annuity, you will get a monthly tax break of around R380.  This is the equivalent of any immediate return of 19%.

• The growth is tax free

The growth inside the retirement annuity does not attract any tax. However, there are negatives

• Access to the funds

You cannot easily access the funds in your retirement annuity before you turn 55.  If you make a withdrawal from the fund in terms of the two pot system, the withdrawal amount will be taxed at your marginal rate.

• Tax on retirement income

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

• Investment restrictions

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 investment

A tax free investment can be used very effectively to provide a retirement income.  You are allowed to invest R36 000 a year into a tax free investment with a lifetime contribution maximum of R500 000.   On the positive side we have:

• Tax free growth

The growth within the investment is tax free and any withdrawals you make from it will not attract any form of tax.

• No investment limitations

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 which should provide a better level of growth over the longer term.

• Tax free withdrawals

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.

• Immediate access to the investment

If you do have an emergency and want to access the funds, you can access 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 into 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 tax free investment 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.