How to invest extra money to maximise your retirement funds

Question: My spouse has no pension or retirement fund. He has just sold a property and now has a few million rand in the bank. Can we put that into my pension or retirement annuity to boost our retirement income? I’m retiring in three years.

Answer: Your spouse cannot invest directly in your retirement fund. Only the registered member can contribute.

However, the money doesn’t have to come from your own earnings. In South Africa, interspousal donations are exempt from donations tax. So, your spouse can give you the property proceeds and you can contribute in your name – completely legally and without tax leakage. But although this can be done, we need to see if it should be done. To answer this question, we need to understand the difference between compulsory and voluntary investments.

Compulsory investments

Compulsory investments are those that are made into your retirement funds, like your company’s or your retirement annuity. You get the following tax breaks:

• Tax deduction: contributions up to 27.5% of your taxable income (maximum of R350,000 a year); and
• Tax-free growth in the investment.

The trade-off for this is that you are compelled to use two-thirds of the proceeds of this investment to buy an annuity at some stage after the age of 55. This annuity will be taxed as income, so the normal income tax tables will apply to it.

Voluntary investments

Voluntary investments are investments that you make using money that you’ve already paid income tax on, typically unit trusts, exchange-traded funds, endowment policies and proceeds from a property sale.

What is notable here is that you do not get any tax break on your investment. However, when you make a withdrawal from it, the bulk of it is classed as a capital drawdown and only a portion is classed as a capital gain. The gain is taxed at a rate of only 40% of your normal tax rate.

The smartest retirement plans blend both compulsory and voluntary investments. Compulsory funds provide valuable tax deductions while you are earning, and they protect growth from tax until retirement. Voluntary funds give you liquidity, lower tax on withdrawals and the ability to top up income without triggering large tax bills.

The real benefit comes in retirement planning, where you can design your income drawdown so that a portion comes from low-tax capital withdrawals, and a portion from annuity income, keeping your effective tax rate lower.

Now, in your situation, you have money in a compulsory investment, being your company’s retirement fund, and your spouse has money in the voluntary investment, being the bank. Managed correctly, your after-tax retirement income can be maximised.

I would recommend the following:

Move the proceeds of the property sale into an investment portfolio. The money in the bank will be triggering interest, which is fully taxable after the initial interest exemption. This is not the case in an investment portfolio. Also, the growth in the portfolio should be better than the growth you are getting at the bank.  

You would need to determine what percentage of your salary you’re currently investing in retirement funds. If it is less than 27.5%, then I would recommend that your spouse donate the balance to you and that you take advantage of this allowance. The value is that you are currently being taxed at a higher rate than your spouse and any tax break you get will improve your retirement savings significantly.

For example, if your current tax rate is 40%, a retirement contribution of, say, R100,000 would only cost you R60,000 as you would be getting R40,000 back as a tax rebate. There is no way your spouse would be getting that kind of return on the R100,000 investment.

When it comes to retirement, good planning can make a significant difference to your retirement savings as well as to the income you can get from your various savings pots. The two of you are in a wonderful position as you have both compulsory and voluntary money, so we can find the optimum structure for you. 

I would recommend that you consult with a financial planner who can help you to check your current taxable income and contributions; maximise the annual deductible contribution until you retire; invest the rest in a flexible portfolio; and design a drawdown strategy that blends low-tax capital withdrawals with annuity income. DM

Kenny Meiring is an independent financial adviser. Contact him on 082 856 0348 or at financialwellnesscoach.co.za. Send your questions to kenny.meiring@sfpadvice.co.za

This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R35.