In an article published in a financial magazine shortly after the delivery of the annual budget speech, a respected local economist made the comment ?? essentially, this was not a good budget for the saver?.?
But is this really the case?
Not necessarily. In fact, long-term savings via a government-approved retirement vehicle have become even more attractive than before. Investors should be informed of the long-term impact of tax changes on different investment vehicles to ensure they have adequate savings.??
The most important tax changes for future retirees relate to capital gains and dividends
The two tax changes that are particularly relevant are:
1. An increase in Capital Gains Tax for the individual from 10% to 13,3%.
2. The introduction of a Dividend Withholding Tax of 15% on all dividends paid to South African individuals.
Investing in a government-approved retirement fund versus a balanced unit trust has different pros and cons
To see really how these changes affect your retirement planning, we will use a case study of a 35-year old individual who wishes to retire at the age of 60 and can afford to set aside R2 500 each month towards retirement. Also, whereas most analysis focus only on the build-up phase (before retirement), we will also take into account the actual retirement phase.
The table summarises the differences between investing in a retirement annuity versus investing in a balanced unit trust as an individual:
To illustrate the impact of the tax changes on the returns of these two savings options, we?ll assume the targeted return for both options is inflation plus 5% after investment management fees of 1% per year, and that inflation is 6%.The tax changes have different implications for the returns on different savings mechanisms
The two tax changes mean the following in our practical example:
1. For the individual investor (option 2), dividends will be taxed at 15%, while in a RA (option 1) there is no tax on dividends.
2. For the individual investor (option 2), any interest above the exemption level will be taxed as income ? we assume an average rate of 35% ? while in an RA there is no tax on interest.
This difference in tax means that the effective return for the RA (option 1) is 11% per year, while for option 2, it drops to 10,5% per year.
A seemingly small impact on returns can make a significant difference in the long run
Even though 0,5% might not seem like a big difference, the compounding of this differential over many years will have a big impact on how much savings you, and your dependants, have at and during retirement.
Focusing on the first two phases of the retirement cycle, the figures in the tables and the chart show exactly to what extent the different tax treatments of options 1 and 2 impact returns over the long term.
In the third phase where the surviving spouse continues to draw the same income based on the same assumptions for another ten years, the difference between the final portfolio values of the two options becomes even more marked.
Investors should decide what their priorities are when it comes to retirement savings and make an informed decision. Investors have different circumstances and views, and some may regard having more control over their money, as in the case of investing in a balanced unit trust, as essential. The final decision will always remain a personal one, but the numbers certainly do tell a story that is worth considering.
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