What would be a good investment for my excess contributions?

Dear reader,

Thank you for your question.

First of all, I will start by making a detour from the previous questions by briefly contrasting a retirement pension and a capitalization policy. Both of these investment policies offer tax benefits in a unique way; however, they differ markedly in tax treatment.

Endowments provide tax advantages to investors with marginal tax rates above 30%, reducing the amount of tax owed on the growth of your investments. Additionally, endowments promote discipline as the investment must be held for at least five years. The investment is taxable in the hands of the investment life insurance company despite its illiquidity due to the predetermined lock-up period of five years. In the event of a financial emergency, there are restrictions on withdrawals made before the required five-year maturity.

Essentially, if your marginal tax rate is above 30%, an endowment policy makes sense because it’s taxed at less than 30%.

Retirement annuities are a tax-saving vehicle where your taxable income is reduced to a set limit, as specified in the Income Tax Act. In any given year, contributions are tax deductible up to a maximum of 27.5% of taxable income or your employer’s remuneration, with an annual ceiling of R350,000.

In addition, contributions in excess of stipulated limits can be used to reduce potential taxes owed on lump sum cash taken before or at retirement age, as well as to reduce the taxable component of your life annuity income at retirement. retirement. Subject to annual limits, contributions made directly by your employer are also taxable as benefits in your hands; however, contributions are also tax deductible available to you but are subject to the permitted annual limits mentioned above. Plus, excess contributions can also be carried forward and deducted in the next tax year, reducing your tax liability.

Based on the above, in my opinion, I would instead suggest the following investment options for your excess contributions:

Retirement pensions

Continue to invest in a retirement annuity for the following reasons:

  • When withdrawing capital in cash before or at retirement age, excess contributions are tax deductible, reducing your tax liability.
  • Deferred excess contributions will reduce the tax payable on your life annuity.
  • By nature, payment of tax on your proceeds is deferred until retirement, allowing your investment to compound tax-free and undisturbed.

Retirement pension and endowment

Distribute the excess contributions equally between the retirement annuity and the endowment policy using a debit order. With regard to the latter, after five years, the proceeds of an endowment contract are exempt from income tax in your hands. Finally, an endowment would be important if your marginal tax rate is above 30%.

Tax-Free Savings Account:

Another alternative would be to place these excess contributions in a tax-free savings account. Interest, dividends or capital gains earned will be tax free in your hands. Growth of your investment and withdrawals from your account are therefore not subject to tax. However, the permitted annual contribution limit is R36,000 per tax year, with a maximum lifetime contribution limit of R500,000.

Mutual fund

I would choose to deploy these excess funds in unit trust investments. Mutual funds offer flexibility, diversification, capital growth based on your risk tolerance and investment strategy, liquidity and estate planning benefits. These investments can increase your retirement income depending on your investment horizon, but it should be noted that withdrawals or transfers from this type of investment may incur capital gains tax.

Direct offshore

Finally, you might consider investing the excess contributions overseas. Offshore investments allow you to invest in underlying funds denominated in foreign currencies (USD, GBP, CHF, etc.). The investment benefits from the performance of the underlying funds and fluctuations in exchange rates.

Minimum investments range from R20,000 to R50,000, depending on the product provider you choose. It is crucial to understand that when making direct investments abroad, you can only invest up to R1 million without applying for a tax clearance certificate; any amount invested above R1 million requires tax clearance from Sars. There is an annual cap of R11 million on the amount you can invest overseas. Upon exchange and withdrawal, this could result in capital gains tax.

We hope the above answers your questions.

The above is based on personal opinion and should not be taken as advice. We invite you to speak with your financial planner and tax specialist for specific advice tailored to your financial situation.

About Vicki Davis

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