Question:
I am trying to decide whether to make my retirement annuity paid up and rather invest my current contributions (R250) directly into a CIS. From my perspective it seems that investing directly into a CIS is more tax effective in the long run. My understanding is that with a CIS the interest income and capital gains are subject to taxation when they are received/accrued. With a retirement annuity I get a tax deduction when I invest the R250 and there is no tax on interest income and capital gains with a retirement annuity. At retirement, 1/3 is commuted into a lump sum and the other 2/3 has to be used to buy a life annuity; subject to tax based on the sliding scale. The annuity pay-out (from the 2/3 used to buy the annuity) is also subject to tax. Is this correct?
Answer:
Elizabeth,
Your are mostly correct. The exception is that you do not pay tax on the amount used to buy an annuity, only the actual annuity income received. The one-third cash lump sum is subject to retirement cash lump sum tax, with the first R315 000 paid out tax free.
It is very unlikely that you would be better off with a CIS. In a CIS you get no tax deduction on your contribution, your interest income is taxed at your marginal tax rate (once you have used up your interest exemption of R23 800), you pay 15% withholding tax on dividends, and you pay capital gains tax. In a retirement annuity, you get a tax deduction on your contribution, you do not pay tax on interest, on dividends or on capital gains.
Say your retirement annuity is worth R945 000 at retirement. You take R315,000 tax free as cash. You convert the rest to an annuity which may pay you around R35,000 per year, if you retire at age 60 and buy an inflation-linked annuity (at current prices). This income would fall below the tax threshold, so you would effectively pay no tax at all on your entire retirement annuity.
Of course, if you receive other income in retirement, your annuity income will eventually attract tax, and if your retirement annuity is worth more, it will also eventually attract some tax. But if you are contributing at R250 pm, that appears unlikely.
The retirement annuity wrapper also stops you accessing your money before age 55. Making your retirement annuity paid-up, you will possibly also incur a surrender penalty, to recover upfront cost (mainly broker commission). By shifting to a CIS you may incur further broker commissions (ie you may be duplicating costs). All in all, this does not seems like a good idea.
