There are excellent tax benefits associated with official retirement products, but these products often come with restrictions. Always understand your options and the rules of the product upfront.
Deciding to start investing for your retirement is the first step. Next you need to choose which tools to use. This requires you to compare products and note their differences.
This step can be quite daunting since there are many products available, but the best way to approach this is to consider your needs and level of self-control.
You are locked in, but with tax benefits
Retirement products are the logical choice for most people saving for retirement due to their tax efficiency. The government provides generous tax breaks to encourage people to invest in provident funds, pension funds and retirement annuities (RA) for their retirement. The catch? Your money is not easily accessible before your retirement.
To limit investment risk, retirement products impose limits on the amount that can be invested in higher risk assets such as offshore investments and equities. These rules can hinder your growth, particularly if you start your retirement savings in your twenties.
Do you want accessibility and tax benefits?
The benefits of retirement products compared to tax-free investment (TFI) products have been heavily debated. Both products grow free of income tax on interest, dividends tax and capital gains tax.
The main difference between the two is that retirement products offer you tax savings now. You end up paying less tax now since you make contributions with earnings on which you haven’t yet paid tax. You only pay the tax later once you start drawing an income. This means you defer paying the tax. TFI products are completely tax-free. You invest money after paying tax, but you pay no tax later.
In a TFI product you are allowed to withdraw your money at any time. This is an advantage if you prefer or require accessibility. Remember though that you could also lose out of the effects of compound interest by dipping into your savings and you have an annual and lifetime limit on contributions, which cannot be replaced once withdrawn. It is important to note that using a TFI in conjunction with a normal retirement product could give you greater access to higher risk investments such as offshore investments and equities.
Do you want an investment with no limits?
You could also consider investing directly into unit trusts. Your contributions, like with TFIs, aren’t tax deductible. And, unlike the other two options, your returns will be taxed. This will reduce your returns, but you benefit from the freedom to invest as much as you want to in any assets and have access to your funds whenever you choose. Once again, the temptation to withdraw your money before your retirement might rob you of the benefits of compound interest.
Understanding the rules of a product is essential before you commit to it. Changing midway could have massive tax implications and may even result in penalties. If you’re uncomfortable doing this by yourself then consult an independent financial advisor to help you review your options.