Our investment industry boasts an impressive array of retirement annuity options for would-be investors, although selecting an appropriate RA from the wide range of available options can appear daunting. With the end of the 2020/21 tax +year almost upon us, now is a good time to consider setting up a retirement annuity if you don’t already have one in place. When choosing an appropriate RA for your purposes, here’s what to consider:
Choosing an investment platform is one of the first decisions you will need to make. Whereas in the past investors really only had access to traditional, insurance-based retirement annuities, we now have access to a range of RAs housed on reputable LISP platforms. Traditional RAs were essentially insurance contracts in the name of the investor which were underwritten by insurance companies. Investors had very little insight into the underlying investments, fees or fund performance – and this lack of transparency made for unappealing investment options. On the other hand, investors can now choose from a wide variety of unit trust RAs that offer competitive investment fees, full investment and performance transparency, together with robust and regular reporting. Unlike an insurance RA, unit trust RAs allow investors full premium flexibility with no fees or penalties for stopping contributions. As such, if you want to invest in a unit trust RA, do your research into a number of reputable LISP platforms and select one that suits your needs.
Your investment timeline together with your propensity for investment risk are factors that you will need to consider before selecting an investment strategy for your RA. If you have a relatively long investment horizon, it is likely that you will be able to take on more investment risk which, in turn, should generate higher returns over the longer-term. However, your investment strategy will also need to give you comfort from a risk perspective as taking on too much risk could leave you feeling uneasy and edgy.
The nature of your earnings
Unit trust RAs are perfect for those who are self-employed, or for those who earn a commission. They are also ideal for employees who do not enjoy retirement funding benefits through their employer. Keep in mind that one is permitted to invest up to 27.5% of taxable income towards an RA (subject to a maximum of R350 000 per year), employees who contribute towards their employer’s pension or provident fund can use retirement annuities to maximise their tax-deductible premiums. For instance, if your employer and employee contributions to your pension fund are at 15% of your taxable income, you will be permitted to invest a further 12.5% of your taxable income towards an RA. As such, when setting up an RA, take into account the nature of your taxable earnings when structuring your investment premiums. For instance, if you are a commission earner or are paid intermittent bonuses, you may want to implement a smaller monthly premium with the option to make ad hoc contributions at tax year-end once you have clearer insight into your annual taxable income.
When setting up your unit trust RA, you are free to structure your portfolio from a selection of underlying unit trusts in accordance with your investment goals. Investing in a LISP platform means that investors are able to transfer their investments to another platform or switch underlying funds as required with no fear of fees or penalties being charged.
Keep in mind that retirement annuities are governed by the Pension Funds Act and, as such, are required to be compliant with Regulation 28 of the act. This regulation effectively limits the underlying investments of an RA in terms of asset classes in an attempt to protect investors against poorly diversified portfolios. In terms of Regulation 28, asset classes are restricted to a maximum exposure of 75% in equities, 30% in foreign equity (plus 10% in Africa), 10% in hedge funds, and 25% in property. With this in mind, it is important to view these limitations and the subsequent effects on your potential investment returns in conjunction with the significant tax advantages afforded by an RA.
Cashflow and liquidity
Cashflow and liquidity are also important considerations when setting up an RA, keeping in mind that the funds housed in a retirement annuity may not be accessed before you reach age 55 – subject to a few exceptions. There is, however, no age limit in respect of retiring from your retirement annuity and you are able to do so at any stage after age 55. When you retire from an RA, you are permitted to take one-third of your money as a cash withdrawal (subject to tax), while the remaining two-thirds must be used to purchase an annuity income. Alternatively, you may use the full amount to purchase an annuity income. Note that if the funds in your RA are less than R247 500, you are permitted to make a full withdrawal on retirement. Once you have purchased your annuity, you are permitted to draw from the investment at a rate between 2.5% and 17% of the capital balance per year, subject to annual adjustment. With this in mind, it is important to find the right balance between investing in a compulsory retirement fund and using a discretionary portfolio to provide liquidity later on.
When taking out a retirement annuity, keep in mind that your spouse may have a claim for a share of the pension interest in the event of a divorce. However, your spouse’s claim to a share of your retirement annuity is not an automatic one and will depend on a number of factors, including the nature of your marriage contract. If you are invested in a retirement annuity, the pension interest refers to the total amount of your contribution to the fund up to the date of divorce plus simple interest at the prescribed rate. If you are married in community of property, your pension interest will form part of the joint estate and your spouse will be entitled to claim 50% of the pension interest at the date of divorce. If you are married with the accrual system, the value of your retirement annuity will be taken into account when determining the value of the accrual. Keep in mind that when entering into an ante-nuptial contract, you are able to specifically exclude the value of your retirement annuity.
Estate planning tool
A significant benefit of a retirement annuity is that it does not form part of your estate and, as such, makes an excellent estate planning tool. Where you have nominated beneficiaries to your retirement annuity, in the event of your passing the funds will be paid directly to your beneficiaries without passing through your estate – meaning that the proceeds are free from estate duty. The funds held in retirement annuities are also largely protected from your creditors, although bear in mind that this does not apply to money owed to Sars or to maintenance obligations.
If you suffer from ill-health which prevents you from working and generating an income, you may qualify for early retirement from your RA before the age of 55, although you will need to meet the stringent requirements in respect of permanent disability in order to qualify for this.
Although you would have appointed beneficiaries to your RA, it is important to note that the distribution of your retirement annuity benefits at death is subject to Section 37C of the Pension Funds Act. In terms of this legislation, the fund trustees are required to determine your financial dependants and to distribute the funds according to their determination. While the trustees will use your beneficiary nomination as a guide, they are obliged to undertake a full investigation to identify those who are financially dependent on you, whether in full or in part.