Question

I am from the UK and have been working in South Africa for a couple of years. I am a South African taxpayer and intend returning to the UK in about five years’ time. My employer has given me the option of either:

• Contributing R350,000 per year to a group retirement annuity (RA), or
• Taking the R350,000 as additional salary and investing it myself.

Which option should I take?

Answer

This is a very relevant question for anyone who is contemplating leaving South Africa in a couple of years’ time.  Does it make sense to contribute to a pension fund while you are working here.

The fact that your employer offers a group RA is a big positive.  This is an excellent product and one which is underutilized.  The way it works is that instead of having a pension fund in place, each the employees of the company each has their own RA which is paid for by the company.  When you return to the UK, the policy remains yours and is not tied to your employer.

I will run through the pros and cons of each option to help you make an informed choice.

Taking the RA option

There are a couple of features of a retirement annuity that you need to consider:

• Immediate tax relief

I have assumed that as your employer is offering the R350 000 retirement payment,  your marginal tax rate is at least 41%.

The R350,000 that your employer will be making on your behalf will give you a tax rebate of R143 500 each year  – a saving of more than R700 000 over the next 5 years

• Tax-free growth

All growth inside a retirement annuity is tax free. Over even a relatively short period like five years, this significantly boosts outcomes compared to discretionary investments.

• The two-pot system helps

Under the two-pot system, you can access one-third of your retirement savings before retirement.  If the RA value after five years is approximately R2.14 million, you could withdraw about R712,000.

This withdrawal is taxable so timing matters. If you make the withdrawal after you stop working in South Africa, your taxable income will be low or zero, meaning the effective tax rate could be minimal if withdrawals are staggered over more than one tax year.

Pension

The remaining two-thirds must be used to purchase a pension after age 55.

Having money invested in South Africa while living abroad is not necessarily a bad thing. Diversification across developed and emerging markets can improve long-term outcomes.

When you want to access these funds, my recommendation is that you make a withdrawal once a year of between 2.5% and 17.5%. If you want to get your funds out of South Africa as quickly as possible you can take 17.5% withdrawal. As you can see the capital will gradually reduce if the investment is earning 10% and you are withdrawing 17.5%

Insider tip: withdrawing after you stop earning local income dramatically reduces tax paid on the annuity

What if you take the cash instead?

If you take the R350,000 as salary, it is fully taxable.  Assuming a 41% tax rate and the same 10% investment return, the numbers look like this:

At the end of the 5 year period, you will have around R1.2m to use as you please . This is about R1m less than the retirement annuity option.  However, as I have shown, there are restrictions on how and when you can access these funds. I would recommend that you discuss these options with a financial planner.