Here’s why you should NOT pay extra into your bond
Ah February, the month of the RA (retirement annuity) top-up.
To minimise their tax liability those with some extra cash will make an additional contribution to their RA or a voluntary contribution to an employee pension fund before the deadline on the 28th of February.
The government wants you to save so that it won’t have to look after you when you outlive your money. To motivate you to save enough there exists a couple of incentives. One such incentive is the pre-tax contribution you can make every year of up to 27.5% of your income for the year (capped at R350,000). By aiming to save up to your maximum allowable deduction SARS will actually owe you money come tax season and you’re building a nice nest egg.
It seems pretty straight forward: you’re young, and you’re working hard, saving a good chunk and servicing your short-term debt well. It becomes a little trickier though when you add your bond, and all that interest, to the equation.
The power of an additional R100 paid into your bond every month is pretty inspiring. According to Dr Simphiwe Madikizela, head of special projects at FNB Housing Finance, upping your bond repayment by just R100 extra every month, on a R500,000 home loan at an interest rate of 10.25 % for 20 years, can save you almost R50,000 in interest and shave off a year and two months from your repayment term. Read more…
Decrease your bond or your tax liability?
To really get to grips with this question it is necessary to look at the example above more closely. The extra R100 over 18 years and 8 months (224 months) is essentially an investment of R22,400 paid in monthly instalments resulting in a return of R49,933.77 (the savings in interest on your home loan). This is an estimated annual return on investment of 7.65% – a pretty significant return.
What if you’d rather taken that saved-up R1,200 (R100 x 12 months) and upped your retirement savings contribution by investing it as a lump sum into a retirement savings vehicle of your choice before the end of February?
Assuming an annual salary of R180,000(R15,000 per month) and an existing retirement savings contribution of R1,500 per month (10% of your annual income) your tax liability would be R29,160 for the year, assuming then that you have no other deduction and based on the 2018 tax table.
Investing the additional R1,200 would decrease your taxable income to R160,800 for the year, resulting in a tax liability of R28,944. A tax saving of R216 which you could then use to decrease your bond if you are disciplined enough with your SARS payout.
But, and this is where it gets exciting.
When investing for retirement it would typically be a long-term investment (in this case 18 years and 8 months) in which case any financial adviser would probably advise investing the money in a balanced fund (a balanced unit trust typically offers a fairly stable long-term return with minimal fluctuations thereby minimising the chances of you losing a great chunk of money just before you retire).
Bonus Benefit: In the case of insolvency your retirement savings are relatively “safe” from creditors. In certain scenarios some money may be deducted but for the most part the money cannot be touched by yourself, or creditors, until you reach the required age. While a property registered in your name would be seen as a part of your assets and included in any judgement against you.
The Association for Savings and Investment South Africa (ASISA) is responsible for unit trust classification. Allan Gray uses the market value-weighted average return of the unit trusts in both the Domestic Asset Allocation Medium Equity and Domestic Asset Allocation Variable Equity sectors of the previous ASISA Fund Classification Standard, excluding the Allan Gray Balanced Fund, as benchmark for the Allan Gray Balanced Fund. This benchmark fund would have shown an annual return on investment of 8.9% over the past 10 years.
Assuming that your R1,200, invested annually just before the end of the tax year, will be invested in a fund that would produce this return over the next 18 years and 8 months you would be left with an investment valued at R53,444.12.
This is R3,510.35 more than what you would have saved had you chosen to direct the R100 monthly towards your bond repayment. Assuming that you don’t ever earn more money and keep your R216 payout from SARS under your mattress for your retirement you will be R7,571.15 richer if you invest in retirement savings instead of channeling the money towards your bond 18 years and 8 months from now.
Of course, leaving your money under your mattress is ludicrous. What would I do instead? I’d maximise my taxable deductions and then use the money SARS owes me to decrease my bond.