I am nearing retirement and plan to draw an income from a living annuity. In addition, I will be receiving a lump sum from the retirement savings. If I use the lump sum in a discretionary investment, already being familiar with the tax implications, will it hold any tax benefit for me if I were to take out a retirement annuity with it?

The way you’ve asked your question makes it clear that you’ve done some research and are familiar with the subject. Well done! For the benefit of the readers and to cover some assumptions I’m going to summarise the back story to your query:

 

• When you retire and withdraw from a pension fund, provident fund, retirement annuity or a preservation fund, part of your accumulated benefit must be used to purchase an annuity which can be in the form of a living annuity, a compulsory annuity or a combination thereof.
• When retiring from a pension fund and a retirement annuity you are entitled to take up to 1/3 of the accumulated value in cash whereas a provident fund allows you take up to 100% in cash. Any lump sum withdrawal, based on current legislation, is taxed as follows:
• Taxable income (R)                            Rate of tax (R)

  1 – 500 000                                          0% of taxable income

  500 001 - 700 000                               18% of taxable income above 500 000

  700 001 – 1 050 000                            36 000 + 27% of taxable income above                                                                       700 000

• 1 050 001 and above                          130 500 + 36% of taxable income above                                                                      1 050 000

• Remember pre- and post-retirement lump sum benefits are aggregated across your lifetime with effect from 1 March 2009. This means that only the first R500 000 you ever withdraw, whether pre- or post-retirement, isn’t taxed; everything you withdraw thereafter is taxed according to the above table.

• You may invest, or spend, a retirement lump sum withdrawal as you see fit.

• If you invest part of your accumulated benefit into a living annuity, you can take an income ranging from 2.5% up to 17.5% per annum with the option to change your drawing level each year on the anniversary of the living annuity. The income from a living annuity (and a compulsory annuity) is taxed as taxable income just as if you were earning a salary.

I’m going to get to any possible benefits of reinvesting your retirement lump sum withdrawal shortly, but there are some planning considerations I’d like to touch on before then. When constructing your retirement portfolio, you need to make sure you have sufficient funds (or liquidity) to last you a period that’s potentially as long as your working career was. Your annuity income may be enough to cover your day-to-day expenses – but what about things like unforeseen medical costs, new tyres, or holidays? If you reinvest your lump sum withdrawal into a retirement annuity, make sure you assess your portfolio’s liquidity profile.

Another consideration is that while you may benefit from investing your cash lump sum into a retirement annuity, you also want to diversify the type of income you get – to keep your tax rate as low as possible. Things like unit trusts and endowments could help diversify your taxable income profile which may in turn help you minimise tax. 

Onto the ‘meat’ of your question. A new section, Section 10C, was inserted into the Income Tax Act and took effect on 1 March 2014. The crux of this section is that ’qualifying annuities’ are exempt from tax to the extent of your own contributions to any pension, provident and retirement annuity fund that was not deductible from income. Basically, your living annuity could be partially or entirely tax free until the disallowed contribution is used up. A disallowed contribution is essentially a retirement annuity contribution that did not qualify for a deduction in terms of the annual deduction limits. There are a few things to take note of here:

• If you make a retirement annuity contribution in the 2020 tax year, it will only show on your e-Filing records for the 2021 year. That means you’ll only get the Section 10C benefit in the year following your contribution.
• The institution that administers your living annuity will pay you a monthly income and deduct pay-as-you-earn (PAYE) according to the tax tables.
• The recipient of the annuity will only get a refund of the PAYE deducted from the investment-linked living annuity (ILLA), when their tax return for that tax year is assessed. This will result from the application of Section 10C to exempt the annuity income. It is applied annually at assessment stage. SARS will not grant a tax directive based on the disallowed contribution.

A quick last point here is that depending on the circumstances a disallowed contribution can form part of your estate on death.

So yes, investing your retirement cash lump sum withdrawal into a retirement annuity could prove to be very beneficial. This should not, however, be done at the expense of liquidity, prudent portfolio, estate and tax planning. 

*Please note that the information provided below does not constitute financial advice; in fact, we are precluded from giving specific advice. Generic information has been applied given the context of your question. We have limited details about you and your circumstances - such detail may impact any advice provided.*