Whether you’re an entrepreneur deciding which options work for your retirement needs or an employee thinking about your company’s retirement saving choices, you’re probably grappling with one or more of the following questions:

• Is there any real benefit in increasing contributions to a pension/provident fund or retirement annuity?
• Should one invest (or increase contributions) into one’s company’s pension/provident fund or instead consider a retirement annuity outside the company?
• How about the difference between investing monthly or a lump sum at the end of the tax year?

Making a decision doesn’t need to be as scary as these unanswered questions make it appear – and we plan on making things a little bit easier for you to choose the right option.

The government wants you to save!

The government has various incentives that encourage South Africans to save towards retirement, and these options include retirement annuities (RAs) and pension/provident funds. It’s important to keep in mind that you can only access a pension or provident fund via an employer whereas RAs are available to everyone.

It’s worth noting that people often use multiple terms to describe retirement funds: RAs, pension funds, provident funds and preservation funds. In general, they are similar in nature, with a few key differences listed below. Unless we are highlighting a specific difference, we’ll always refer to the generic retirement fund.

Let’s start with retirement annuities 

Anyone can invest in a retirement annuity, so if you’re self-employed this is a great option to consider for your retirement needs. You can generally start saving at an affordable rate: some debit orders start from R250 per month, (most average around R500 per month), and a once-off lump sum investment can start from R10 000.

With an RA, you can only access your money from the age of 55 years; and you cannot make once-off ad hoc withdrawals prior to this, unless you become permanently disabled, emigrate, or your investment is below the prescribed minimum regulated amount, which is currently R7 000.

When you reach 55, you have the option to “retire” from the product. There is no maximum age to retire, and this event doesn’t need to coincide with your actual retirement from an employer, so you can be flexible with your retirement planning.  When you retire from the product, if you decide to withdraw a portion of the investment, you can only access one-third and at least two-thirds must be used to purchase a living annuity, a guaranteed annuity, or a combination of them.

What about pension and provident funds?

To contribute to a pension or provident fund, the option needs to be offered by your employer where, in most cases, it’s compulsory to contribute . When you leave the employer you then need to decide whether you want to preserve your money in a ‘preservation fund’ or take a full or partial withdrawal. Withdrawing your money is never recommended. Once you have transferred your funds into a preservation fund, you are able to take an additional once-off withdrawal.

When you retire from your employer, you will also need to retire from your employer pension/provident fund. The rules are similar to that of an RA: you can only access one-third of your money and at least two-thirds must be used to purchase a product that provides you with an income. Any contributions that you made to a provident fund before 1 March 2021, however, may be cashed out in full, in accordance with old provident fund legislation.

Preservation Funds

When you leave an employer, you will need to decide whether you want to preserve the money you have saved in the employer fund in a preservation fund or take a full or partial withdrawal. Withdrawing your money is never recommended as it can have a severe impact on your ability to retire comfortably one day. Once you have transferred your savings into a preservation fund, you are able to take an additional once-off full or partial withdrawal before you retire. The retirement process is the same as that of a RA.

Now that you have an understanding of the type of retirement funds available in South Africa, let’s get into some details to help you make a decision.

Is there a real benefit to increasing contributions?

The short answer is yes. Whether you choose to add more money to a pension fund, provident fund, or an RA, the government incentivises you by reducing the amount of tax you pay.

When you think about adding more money to your retirement fund, let’s say an additional 5% above your current contribution, the first thought that pops into your mind might be that adding an additional 5% equals an automatic 5% reduction in your salary. This is not always the case. To explain why, below is a simple example which does not include other deductions like medical aid:

Let’s say you earn R220 000 a year and contribute 10% to your pension fund. Your 10% contribution for the year is R22 000. When SARS looks at the tax you owe, they don’t see you earning R220 000 a year, they see you earning R198 000 (i.e. R220 000 less your contribution of R22 000). You are not taxed on your retirement contributions, subject to maximum limits. According to SARS’ tax tables, when you earn R198 000 a year, you will pay R21 592 in taxes, without considering any other deductions such as medical aid contributions.

Knowing that information, you wonder what the implication would be for increasing your contribution by 5% so that your new contribution to your pension fund is 15%. You still earn R220 000, but a 15% contribution now equals R33 000 per year. As mentioned above, SARS will now see your earnings as R187 000 (R220 000 less R33 000), resulting in you paying R19 440 in taxes a year.

As shown in the example, adding an additional 5% to your pension fund had two advantages:

1. You reduced the tax you pay SARS from R21 592 to R19 440 because you now fall into a lower tax bracket (but this is not always the case)
2. You increased your contribution to your pension by an additional R11 000 per year

Remember, you are allowed to invest a maximum, tax-deductible contribution of 27.5% of your remuneration or taxable income (whichever is higher), capped at R350 000 per tax year. Tax-deductible contributions simply mean you can reduce the amount of tax you pay by contributing more to a retirement fund! And keep in mind, that more you contribute to your retirement savings early on, the more you can take advantage of the power of compound interest and grow your savings.

Company’s pension/provident fund versus a retirement annuity

When considering which retirement saving option is better, there are four main points to consider. Firstly, if you choose to contribute to your company’s pension or provident fund, you will receive an immediate tax benefit. Your company will calculate your new (lower) tax payable each month and there is no need to submit a separate claim for a tax deduction from SARS. If you choose to contribute to an RA outside of your company’s pension or provident fund, your tax benefit is a little delayed because you will need to wait until the end of the tax year to submit your tax return. SARS will then have to process your return and you’ll have to wait for them to pay you back – but only if there is a benefit due to you. To mitigate this risk, be sure to check the details of any RA contributions are correctly disclosed in your tax return.

The second point to consider is that RAs are a lot more flexible. When you choose an RA outside of your company, you can choose the amount of your debit order or lump sum (provided that you meet the minimums). Another benefit with the flexibility is that you can increase or decrease your debit order, choose when it goes off, and decide on the amount of your lump sum at any time. Whilst most modern RAs do not try to lock you into the investment in any way, be sure to check the terms and conditions of a RA investment carefully before you invest, to ensure you understand any minimums terms and exit penalties which may be in place, as it could erode your savings. If you choose your company’s pension or provident fund, you generally need to make the choice upfront and can only change it once a year.

Then, when you choose to maximise your benefit with your company (i.e. a pension/provident fund), the funds that are offered are generally limited to a predefined list or just one fund. Your funds are also, in most cases, not managed based on your risk profile and you could end up with a fund that does not match your investment objectives, forfeiting any potential upside investment returns. When you choose an RA, you have access to a wider range of funds and you or your financial adviser can manage your risk profile as your lifestyle changes.

Lastly, since the trustees of a larger employer pension/provident fund can negotiate in bulk on behalf of all its members, you may pay a slightly cheaper fee for investment management than when you would when investing in your personal capacity in an RA. This small fee discount will compound over time.

Which is better, monthly payments or a lump sum at the end of the tax year?

You’ve probably heard reminders over the radio, read an article sent by a wealth management firm, or received an email from your employer reminding you to add money to your retirement fund before the end of the tax year. You may have panicked and frantically tried to sort out last minute contributions – and even may have asked, ‘wouldn’t it be easier to invest every month rather than at the end of the tax year?’ It’s an important question and, while it’s easier to invest monthly, there are a few things you should consider.

Committing to investing an additional amount monthly allows you to adjust your finances and get comfortable living on less. Two things you should consider are affordability and time in the market.

From an affordability perspective, do you have the budget to invest monthly? You may wonder if it will affect your salary or whether you can no longer do something fun with that money, but as shown in the examples above, it could push you into a new tax bracket that could reduce the amount of tax that you pay and increase your contributions to your retirement. An additional point to consider from an affordability perspective is that it’s always good practice to annually reassess your finances and take the opportunity to clean up some unnecessary expenses. This could free up additional money and help you contribute more to your retirement.

When you plan for retirement, you are generally planning for the long term, and when you take a long-term view on investments, you’d expect that your investment gives you positive returns in the future. Generally speaking, the earlier you invest, the longer your money has time to grow and you reduce the risk of investing on one day when the price may not be favourable.

So, what’s the best option? That depends on your lifestyle. But now that you have all the information, you are able to better understand the consequence of your decision. If the options are still giving you sleepless nights, however, contact a financial adviser to help you manage your financial future.

*This article, was originally published on 12 February 2020. It has since been updated to reflect 2021 rules and regulations.