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First-time investing: setting up your retirement annuity

A step-by-step guide on how to choose and set up an RA that is appropriate for your needs and circumstances.

If you’re starting out your investment journey, it’s likely that you’re considering setting up a retirement annuity. That said, the retirement funding industry is complex and heavily regulated, and knowing how and where to begin can be somewhat confusing. As a first-time investor, here’s a step-by-step guide on how to choose and set up an RA that is appropriate for your needs and circumstances:

Determining how much to invest

As you are no doubt aware, you are permitted to invest up to 27.5% of your taxable income per year (subject to a R350 000 maximum) on a tax-deductible basis, making RAs particularly attractive long-term investment vehicles. When starting out, the first step is to determine the optimal, most tax-efficient level at which you can contribute towards an RA.

When calculating your taxable income, bear in mind that there are a number of other income sources over and above your salary that should be taken into account. Rental income, after deductions for allowable expenses, must be added to your taxable income. Further, dividends earned from real estate investment trusts (Reits) are subject to income tax in a taxpayer’s hands and are therefore included.

Gains derived from the realising of capital assets such as property or unit trusts may result in a capital gain which should be included, bearing in mind that the first R40 000 is excluded. Once you have calculated your taxable income for the current tax year, you will be in a position to determine the maximum tax-deductible amount you can contribute towards an RA.

Understanding your liquidity needs

Before committing to investing at the maximum level, give careful thought to your short- to medium-term cash flow needs. Keep in mind that you will not be able to access the funds in your RA until at least age 55, so if there is a chance you may need access to some capital before that you may want to consider alternatives. For instance, you may consider investing a smaller percentage of your taxable income towards your RA while using the balance to invest in a discretionary unit trust portfolio. This will ensure that you have access to capital in the short- to medium-term and, if this capital is not required, you can always transfer it into your RA before the close of the tax year. 

Choosing an investment platform

One of the first decisions you will need to make is which investment platform to use. There is a large array of reputable LISP platforms to choose from, for instance, Ninety One, Allan Gray and Old Mutual Wealth, which provides investors with an array of funds from which to select, including both their own funds and funds of other asset managers. Most major LISP platforms have similar fee structures and offerings, but it remains important to do your research and read the fine print. As an aside, you do have the option of taking out a retirement annuity on an insurance platform, although keep in mind that this is fundamentally different from investing on a LISP platform. An insurance RA is essentially a policy owned by you through which you are contracted to the insurer and is not a separate investment held in your name.

Choosing a fund

As an investor, you have over 1 500 unit trust funds to select from, but keep in mind that retirement annuities are regulated by Regulation 28 of the Pension Funds Act and you will need to ensure that whatever fund you select, or combination of funds, is Regulation 28 compliant. Once again, it is important to investigate the fee structure of the fund/funds you choose, keeping in mind that same investment platforms offer administration discounts if you invest in their own funds.

Choosing a multi-manager

If selecting a fund or combination of funds is overwhelming, you may want to consider using a multi-manager. Asset management and the selection of underlying unit trusts requires an enormous amount of expertise and skill, and a multi-manager approach has proven to be of huge value to many investors. The role of the multi-manager is to actively research and assess the various funds, and to select a blend of fund managers for your portfolio. They actively manage the process of re-balancing your portfolio and re-calibrating it in line with your specific investment mandate. Due to economies of scale, you will find that many multi-managers can provide competitive investment fees.

Selecting an investment strategy

Once you have chosen a provider and investment platform, you will need to select an investment strategy that is appropriate to your needs. In this regard, there are a number of factors to be taken into account including your investment timeline, the age at which you plan to retire from your RA, your propensity for investment risk, and the returns you need in order to meet your income objectives. That said, keep in mind that your retirement annuity will be subject to Regulation 28 of the Pension Funds Act which limits equity exposure in the fund to 75%. Further, investors are restricted to 25% in local or international property, and 30% in foreign investments. If you are invested for the long-term, remain cognizant of the fact that inflation and longevity are your two greatest retirement risks, and careful planning involves mitigating these risks as much as possible. If you invest too conservatively over a long period of time, the effects of inflation can diminish the purchasing power of your income over time. Further, if you underestimate your life expectancy, you could find yourself in a position where you outlive your retirement capital.

Submitting your application forms

From an administrative perspective, you will need to complete the application relevant to the investment platform or multi-manager you have chosen. The information you will be required to provide includes all your personal details, bank account details, the level and frequency of your contributions, a debit order instruction, the name and details of your financial advisor, your identity documents, the source of your funds, and your tax information. When determining the level and frequency of your contributions, give careful thought to the nature of your income. If you are a commission earner or are paid incentives and/or bonuses as part of your remuneration, you may want to consider committing to a smaller monthly debit order with the option of making ad hoc contributions as and when you receive your commission payments. Having said that, remember that you can stop and start your RA contributions as you see fit without fear of any penalties or fees only on unit trust-based or LISP platform RAs.

Nominating your beneficiaries

When setting up your RA, you will be required to nominate beneficiaries to your investment. However, it is important to note that it is the trustees of the fund who remain responsible for allocating your benefits in terms of Section 37C of the Pension Funds Act. This means that, in the event of your death, the trustees will need to identify your financial dependants and then decide how best to distribute the funds between them. As such, your beneficiary nomination will serve as a guide to the trustees when determining the distribution of your RA funds.

Filing your tax returns

When you submit your ITR12 income tax return to Sars, you will need to include all tax-deductible expenses for the year of assessment, including the contributions you made to your RA. At the end of the tax year, your RA provider will provide you with a retirement annuity contribution tax certificate IT3(f) as proof of your investment which Sars will then use when determining your tax refund. Rather than view your tax refund as a financial windfall, think carefully in advance how you intend to use this money most effectively. For instance, you may want to park the money in your access bond so as to reduce your monthly bond repayments or use it to bring your emergency fund to a more adequate level. If you’re not contributing the maximum tax-deductible amount towards your RA, you may even consider using this capital to make an ad hoc contribution towards your RA.

As a cautionary word, insurance RAs which are essentially long-term insurance products can be expensive and complex products. Many also do not deliver adequately in respect of transparency, reporting and investment returns. In addition, many traditional insurance RAs do not allow investors to change their monthly premiums or make ad hoc payments, and can charge penalties for early cancellation of the policy. To ensure that you invest in a reputable LISP investment, it is always advisable to seek independent financial advice.

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