How to pay zero tax in retirement

When an acquaintance recently turned 64, he said he “couldn’t wait” for his next birthday.

The people around the table at his birthday party were taken aback. Most people don’t look forward to getting older. Why was he so excited?

“Because from next year, I will pay less tax!” he quipped.

He was right, of course. At age 65, individuals get an additional tax rebate. A higher annual interest exemption also becomes available.

The comment sparked a question. What type of income would a couple be able to draw in retirement before they would have to start paying tax? Naturally, there are various ways of reducing one’s tax liability, particularly if you use clever structures, avoidance techniques and the like, but what if you kept it simple? In other words, no contributions to retirement annuities or investments in Section 12J venture capital companies – just using the main tax thresholds, rebates and exemptions allowed?

The example below is intended as an illustration and covers the tax year that will end on February 28, 2019. The assumption is that the taxpayer and her spouse are 65 or older, but not yet 75, that they have retired and don’t have any additional income beside their annuities and discretionary investments.

Income, interest and tax-free savings

At age 65, the income tax threshold is R121 000 per annum. In other words, an individual would be able to draw an annual income of R121 000 from an annuity without paying any income tax.

The interest exemption is R34 500, and the same individual would be able to draw R34 500 from an interest-bearing investment before the Tax Man would come knocking.

Tax-free savings accounts were introduced on March 1 2015. Assuming the taxpayer contributed the maximum amounts allowed to these accounts every year, the capital value would be R126 000 ((R30 000 pa x 2) + (R33 000 pa x 2)), says Martin de Kock, director at Ascor Independent Wealth Managers.

To keep the calculation fairly simple and conservative, the assumption is that there has been no growth on these accounts and that the return on the investments for 2019 was 7%, giving the investor a tax-free income of R8 820, he adds.

This means that the couple could get a tax-free income of around R328 640 per year (R164 320 x 2), which amounts to R27 387 of income each month.

Assuming they don’t have any debt or rental expenses, no dependents and limited medical overheads, this would be a reasonable amount of money to live on.

Capital gains

Where retirees have share portfolios or other equity-type investments like unit trust funds outside a retirement annuity vehicle, this could also be used to supplement the monthly income of R27 387. These investments are also referred to as discretionary investments or funds.

However, this calculation is somewhat more complex since the tax-free “income” that could be derived by selling shares, would be highly dependent on the capital growth in the portfolio.

Currently, the annual amount above which capital gains become taxable is R40 000. In other words, if the capital gain on shares sold is R40 000 or less, no tax will be payable on the proceeds. Where a share portfolio had good capital growth over a longer period of time, an individual may be able to sell say R100 000 worth of shares before the R40 000 threshold would be triggered. However, if the share portfolio did not perform well and your growth is limited, you may need to sell much more shares or units to generate the tax-free capital gain of R40 000. From a cash-flow perspective, this makes it difficult to use these amounts for planning purposes in an example like this, De Kock says.

Compulsory and discretionary funds

Since pensioners may not be in a position to generate additional income in retirement, and taxes can make a big difference to their situation, it is important to get appropriate, independent advice prior to retirement.

De Kock says from a tax perspective, if could be sensible to create an additional pot of discretionary funds alongside the funds saved in a retirement vehicle like a pension fund, provident fund or retirement annuity leading up to retirement. Individuals would then be in a position to draw an income from their discretionary funds (for example money in a cheque account), which could be utilised without tax implications (this is after-tax money). This could allow retirees to keep their overall tax rate as low as possible (even zero) during the first few years of retirement, while still allowing funds in the retirement vehicle to grow (assuming it is a living annuity). As the discretionary funds deplete over time, more income could then be drawn from the annuity and at age 75, another tax rebate will become available (albeit a fairly small one).

Ultimately, tax is only one of the various factors retirees need to take into account when structuring their financial affairs. It is no use putting money in a bank account to save a few rand in taxes, if it means the investor will need to forgo significant capital growth. Decisions around tax structuring must make sense within a broader financial plan.

“Doing retirement planning and focusing too much on tax could lead to bad results – beware!”

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