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BOITUMELO NTSOKO: Today, we are exploring an essential aspect of retirement planning in South Africa, Section 10C of the Income Tax Act. We’ll uncover how investors can leverage this provision to optimise their retirement savings and potentially enjoy tax-free income during their golden years. 

Joining us today to share insights on this is Elke Brink who is a wealth advisor at PSG Wealth. Welcome, Elke. It’s a pleasure to have you on the show.

ELKE BRINK: Thank you so much, Boitumelo. Good to be here.

BOITUMELO NTSOKO: Elke, can you explain what Section 10C of the Income Tax Act is and its significance in retirement planning?

ELKE BRINK: Yes. Section 10C is a very under-utilised benefit when it comes to your retirement planning, and this is specifically for post retirement, after the age of 55, to have a really cool benefit that you can utilise and which a lot of investors are not aware of. Basically, what it comes down to is that pre-retirement, you have a tax benefit or a deduction you can utilise when it specifically comes to your retirement funds. 

What the rule says is you are allowed to save up to 27.5% of your taxable income within a retirement annuity or your pension or private fund at work, or a combination. You can claim these contributions, the 27.5%, back from Sars on an annual basis up to a maximum of R350 000 a year. So you have this deduction. 

But if you were to contribute anything over and above either your 27.5% or your R350 000 a year, this is referred to as a ‘disallowed contribution’, and it essentially starts pooling up in a separate pool, if I can refer to it like that, and you can optimise this benefit once you get to retirement – as I’ll explain now. 

In principle, you can’t use it now, before retirement. You can’t use it as a deduction, but this pool that we build up we can at retirement offset against your income tax that you will be paying at that stage. So the moment you retire, we reconvert your retirement portfolio to either a living or a life annuity, where you now start drawing an income and this income is taxed on the income tax scale normally, like your salary is taxed at the moment.

So you are just taxed on a normal scale, and this income tax is allowed to be offset by this disallowed pool. So the larger the pool you can build up, you can essentially not pay tax for a few years within retirement.

BOITUMELO NTSOKO: Okay. Could you walk us through how investors can make the most of this provision and improve their retirement savings?

ELKE BRINK: Yes. There are a few benefits, not only for the income-tax saving you can create in future, but [also] in the interim. So before retirement, but also after retirement or during retirement, anything that’s in your retirement product – let’s say, pre-retirement or post-retirement in your living or life annuity, is excluded from your estate. So it’s actually a really cool benefit to optimise these benefits to ensure you’re taking care of your loved ones. There is also something to take into account with the disallowed contributions, which I will elaborate on a bit later. 

But in principle, I would recommend that any investor focus – as soon as you can in your lifetime – on saving more than your annual deduction, more than your 27.5% or R350 000 maximum within your retirement portfolios, as you start building up this pool over a lifetime.

It’s not necessarily something you have to do before retirement. For example, investors who have already reached 55 or more can in one moment transfer a lump sum to a retirement annuity, and the next day or in the next few weeks transfer it to your living annuity.

So you can optimise Section 10C within a few weeks if you have a large lump sum available to exceed that R350 000 a year.

But for the average person, it’s easier earlier on in life out of a cash flow perspective to do it earlier on – so to basically do your 27.5% and more the moment it is affordable for you.

BOITUMELO NTSOKO: Elke, during the pre-retirement stage if an investor has a retirement annuity and a pension fund at work, which of these should they optimise?

ELKE BRINK: I always recommend when you have a personal retirement annuity and a benefit at work to do a bit of an analysis on it in terms of how it is invested. It very much depends on what strategy your employer is following with the investment.

But a wealth advisor can do a proper analysis for you in terms of the diversification, the return, perhaps with the underlying fund manager you have, and then I would recommend choosing the optimal portfolio between your individual capacity or the group capacity. 

In most cases, sometimes as an individual, you have more options in terms of underlying fund managers on an individual basis compared to a group scheme, but that’s not always the rule. But I would recommend an analysis and choosing the best-performing and best-diversified route to go.

BOITUMELO NTSOKO: Now, when you are at the retirement stage, how do these disallowed contributions come in handy?

ELKE BRINK: When we reach retirement, this is actually quite convenient, because Sars keeps a record of the disallowed contributions, so it automatically knows about it when you reach that stage. It has to be over the age of 55. And then what is quite important is that, when it comes to the income tax that we now want to set off this pool again, it can be offset only against an income earned from a living annuity or a life annuity, not other sources of income, for example, rental income or something. It has to be the living annuity or the life annuity. 

The moment you then retire and you have this post-retirement product – the living or life annuity – and it automatically happens with Sars, I normally recommend using your accountant or tax practitioner together with your wealth advisor to ensure that Sars is aware of your disallowed contributions. Then automatically we can now offset your tax and then essentially, depending again on how big your pool is, you don’t have to pay income tax until this pool is depleted.

So as a random figure, let’s say, you have a R1 million built up in your pool and you are earning an income that triggers roughly R100 000 in tax on an annual basis, you can for 10 years not pay income tax.

So this is actually a wonderful benefit in terms of, of course, obviously ensuring you have sufficient retirement provision, but also creating a very tax-efficient retirement. A lot of investors tend to forget that at retirement you still have this income-tax duty, so it can potentially be a large part of your income that you are sacrificing to income tax.

BOITUMELO NTSOKO: Elke, I just want to take a bit of a step back. If you have these disallowed contributions, are you allowed to withdraw a bit more when you retire – just above the R550 000 limit?

ELKE BRINK: Yes. There are two ways to optimise a disallowed pool. You can do a lump-sum withdrawal, so that would be a once-off benefit you get. So in principle when we reach retirement, at the moment legislation states you have R550 000 tax-free. It is always quite important just to do an analysis at that stage, because if there are any funds owed to Sars, or if you have ever been retrenched, this can impact the R550 000. But in principle we have R550 000. 

Let’s say your disallowed contribution was another R500 000. You essentially have another R500 000 you can add to your R550 000 that will be tax-free, and then you withdraw this as a lump sum. So this is a bit of an either/or. Either you can take a large tax-free lump sum at retirement, or you can decide to offset that lump sum against your income tax on, let’s say, a monthly/annual basis until the disallowed pool is depleted.

BOITUMELO NTSOKO: Elke, could you elaborate for us how investors can utilise disallowed contributions to minimise taxes on their retirement income?

ELKE BRINK: Yes. This only happens once you have now converted. Let’s say you have a combination of a retirement annuity and a pension or a provident [fund] at work. The moment you retire we consolidate these investments and we open up, for example, a living annuity for you after retirement. This living annuity income needs to now be between 2.5% and 17.5% of fund value. [The] income percentage you choose, will [determine] what tax is payable on the income-tax scale for you as an individual, and that income can now be offset against your disallowed contribution. So, very importantly, this benefit is actually only for when you reach retirement; you can’t utilise it before retirement.

BOITUMELO NTSOKO: And will life annuity investors have this benefit as well?

ELKE BRINK: Yes. Again, you can also offset it against your income tax. So it’s specifically for living or life annuities until the pool is depleted. The larger you can build the pool, the longer you don’t have to pay income tax at that stage in life. 

What is important is what I wanted to mention earlier in terms of estate planning.

In principle, a retirement annuity – or a pension or a provident fund or any pre-retirement retirement product – or a living or a life annuity post-retirement is not included in your estate. So these benefits go to your beneficiaries nominated immediately.

But the disallowed pool is seen as an asset in your estate. So that’s quite important; if you have not depleted your pool yet that little excess part will form an asset in your estate when it comes to estate-duty purposes.

BOITUMELO NTSOKO: And Elke, can other investments complement Section 10C to help investors create a tax-free retirement income?

ELKE BRINK: What I normally recommend when we’re planning the perfect retirement, if I can explain it like that, is to try to see not only that we are creating a tax-efficient portfolio, but also some liquidity in your portfolio for emergencies or holidays or any unforeseen expense.

Normally what I would recommend, something to keep in mind if we are benefitting from the 10C, is all kinds of restrictive products in terms of a retirement annuity or a pension or a provident fund, especially with the two-pot system coming in, or post-retirement the living or life annuity – all of these products can’t be accessed as a lump sum. 

So I normally recommend optimising a tax-free investment, which again brings a big tax benefit to your portfolio. So this is the investment that you are allowed to do – the R36 000 per year and R500 000 in your lifetime, contribution wise; but it can technically grow to wherever.

So if you can optimise this investment, which is an accessible investment, you can potentially build up another few million, depending on your timeline; but it’s 100% accessible and it’s tax-free. You can build this up as an additional source of income with your living or life annuity, knowing that you have readily available funds for whatever additional expenses you have. 

And then normally I would also recommend optimising a normal voluntary or flexible investment. Again, the reason for this would just be to have some liquidity in your portfolio at retirement. As an individual, you have certain annual exemptions, for example, on interest and on capital gains tax payable; this normally refers to equities. 

So if you as an individual optimise all of your possible tax benefits annually, then you can have a few different products but have the most tax-efficient environment because you’re optimising all the different benefits you have.

BOITUMELO NTSOKO: Elke, before we wrap up, do you have any final tips or advice for our listeners regarding retirement planning and tax optimisation?

ELKE BRINK: I think maybe to wrap up, I would recommend that investors start earlier on in life to ensure that they are making the most of all their tax optimisation.

You can have a perfect portfolio, earning double-digit returns, but if you’re not planning sufficiently out of a taxation point of view, tax hurts you a lot in the end; and the higher net worth individual you are, the more tax is going to hurt you.

So tax is equally as important as the portfolios and the returns you are getting. 

So it’s making sure that you are planning from a taxation point of view and not being scared of a retirement fund. I think there is sometimes a misaligned reality in South Africa that people are scared of the restrictiveness or scared of a retirement fund, whereas there are exceptional benefits within these products if you really understand the estate-planning benefits and the tax benefits. Of course, if it’s managed properly you can earn very good returns.

So one of the main pre-retirement benefits that changed in the past year was that you are now allowed to invest up to 45% offshore; it was always 30%. So there’s also a very good diversification benefit. Really there are so many pros to using this product optimally in your portfolio – and I think for the average person out of a cash flow point of view and a planning point of view it’s just easier doing it on a monthly basis.

The more time you have, of course, with any investment portfolio, the better. It just has that compounding effect, and it doesn’t have such a cash-flow constraint later on in life.

BOITUMELO NTSOKO: Thank you so much, Elke, for sharing your expertise with us today.

ELKE BRINK: Thank you for your time.