Question:
Is it advisable to inject an annual lump sum into your provident fund to increase your returns at 55, also for tax purposes? PROVIDENT FUNDS - The difference between a Pension and a Provident Fund is as follows: An individual does not get a tax deduction for making a contribution to a Provident Fund himself, but if the employer contributes to a Provident Fund on the employee's behalf, the employee will not pay tax on that contribution.
Answer:
Errol, ,
The more you save, the more money you will have at retirement. You will not benefit from an immediate tax deduction unless you structure the lump sum contribution as a salary sacrifice (in conjunction with your employer), and your contribution does not then exceed the employer's deduction limit of 20% of pensionable salary. But even if you don't get the immediate tax deduction, your contribution still earns tax-free investment income in the fund until you retire, and any contributions not claimed for tax are returned to you tax-free. Saving through the provident fund is also likely to be cheaper than saving through a retail product (retirement annuity or unit trust).
One critical issue is the rate at which your investment income on the additional contributions is taxed in retirement. If the additional return is added to your cash lump sum, that income will likely be taxed at 36%, which is higher than the likely average tax rate you will pay on that income arising from withholding tax on dividends, tax on interest and capital gains tax (if you invested the annual lump sums in your own name). If you converted the provident fund to a living annuity, then the tax differential would be less clear and depend on how much you were drawing annually. So in concept it is a good move (ie saving more), but if you are weighing up savings alternatives, you need to consider the relative tax implications.
