We’re all familiar with the term ‘retirement annuity’ and the significant tax benefits associated with this type of investment vehicle, but there are some lesser-known details and benefits about RAs that all investors should know about.
1. You can transfer your insurance RA to a unit trust platform
If you’re sitting with an old school, insurance-based retirement annuity, you can transfer your investment to a unit trust platform, although there are a number of factors to consider before making a decision. The process of transferring your RA from one service provider to another is governed by Section 14 of the Pension Funds Act and can take a number of months to complete. However, the decision to transfer should not be made as a knee-jerk reaction to high fees, poor investment performance, or poor administration – but rather as part of a holistic investment strategy.
Insurance-based RAs are effectively insurance policies and it is important to fully understand the policy fine print before making any final decisions. Being an insurance policy, there may be guarantees linked to the policy, or other benefits such as life and disability cover which may fall away if you transfer your investment to a LISP platform. In addition, there may also be penalties and/or fees involved for the early termination of the contract which your current insurer should be able to provide a breakdown of. These penalties are designed to recover the upfront commission and other costs when the policy was implemented.
Once you have a full understanding of the costs and penalties involved in the transfer, your advisor should be able to prepare a cost-benefit analysis to determine whether the costs involved outweigh the long-term benefit of transferring to a new RA.
Also important to note is that the money invested in your RA is effectively housed in a tax wrapper which means that it will not attract tax when transferring from one approved retirement fund to another. If you transfer your insurance RA to a new generation RA which is housed on a LISP platform, no expensive upfront commissions will be paid to your financial advisor as in the case of an insurance RA. Your financial advisor will earn what is referred to as ‘as and when’ fees which is essentially an advice fee that is charged per annum and is calculated as a percentage of your invested capital.
2. You can use an RA to preserve your retirement benefits
When leaving an employer, it is almost always advisable to preserve your group retirement benefits rather than cash them in. While a preservation fund is an excellent vehicle in which to house such benefits, keep in mind that it is not the only option available to you. Transferring your group retirement benefits into a retirement annuity structure has some significant advantages which should be weighed up against the unique features of a preservation fund.
If you transfer your funds to a preservation fund, you will not be able to make any additional contributions towards the investment. The only time you can add funds to a preservation fund is where they originate from another approved retirement fund. On the other hand, if you transfer your funds into a retirement annuity, you can continue contributing towards it on a regular basis and can make additional ad hoc contributions as and when circumstances allow.
Preservation funds provide investors with a significant advantage in that they are permitted to make one full or partial withdrawal from their investment before the age of 55. Retirement annuities, however, do not allow investors access to their funds prior to age 55 so it is important to be sure that you will not need access to your capital before this age.
Either way, no tax is payable on the transfer of retirement benefits into a preservation fund or retirement annuity.
3. You can have as many RAs as you like
You can open as many retirement annuities as you like, although you need to be clear on the reasons for doing so. Remember, you are permitted to invest up to 27.5% of your taxable income on a tax-deductible basis towards an RA, with this limit being applicable to the aggregate of all your contributions towards an approved retirement fund. There is therefore no tax advantage to having more than one retirement annuity.
If your RA is invested on a LISP platform, you can fully diversify your investment strategy – within the limitations of Regulation 28 of the Pension Funds Act – within a single retirement annuity, meaning that additional RAs will not create opportunity for extra investment diversification. If possible, it, therefore, makes sense to contribute towards a single retirement annuity using an investment strategy that is fully aligned with your investment goals and horizon. There is an annual limit of R350 000.
4. RAs are more tax-efficient than TFSAs
When it comes to tax on investment returns, retirement annuities and tax-free savings accounts (TFSA) present the same tax efficiency for investors. No tax is paid on any dividends or interest earned in either an RA or a TFSA, and there are no CGT consequences. The big difference between the two investment structures is that your contributions towards an RA are tax-deductible, whereas your contributions towards a TFSA are made with after-tax money. As such, TFSAs become attractive investment vehicles once you have maximised your tax-deductible contributions towards an RA.
5. The funds in your RA are protected from creditors
If you are declared insolvent, Section 37B of the Pension Funds Act provides that the funds in your retirement annuity are protected from your creditors, although this does not mean that your RA funds enjoy complete protection from creditors. In terms of the Act, certain monies can be deducted from your pension fund money, including money owed to Sars, and amounts due and payable under the Divorce Act and Maintenance Act.
6. Your over-contribution will rollover
While your tax-deductible premiums are limited to R350 000 of your taxable income per year, this does not mean that you cannot invest more than this in a tax year. This is because any over contributions are rolled over to the following year and can be used for tax deduction purposes in that year. The advantage of this is that the over-contribution will still enjoy investment growth, even though the tax benefit will only be gained in the following year.
7. The funds in your RA are not subject to estate duty
The money invested in your retirement annuity does not form part of your deceased estate and will therefore not be taken into account for estate duty purposes. This is because the distribution of your retirement fund benefits in the event of your death is the responsibility of the fund trustees who are required to follow the procedure set out in Section 37C of the Pension Funds Act. In terms of this legislation, the trustees are required to determine who your financial dependants are at the time of death, and to distribute the funds in line with their determination. As a result, the executor of your deceased estate does not administer your retirement fund benefits which fall outside of the estate.
8. You can use your RA to reinvest your tax returns
An effective way to use your retirement annuity is to reinvest the tax returns you receive from Sars. At the end of the tax year, you will need to submit your IT3 certificate to Sars as part of your e-filing providing proof of the contributions you’ve made towards your RA in that tax year, following which Sars will refund you the tax on those contributions. You can then use your Sars refund to top up your RA in the subsequent tax year.
9. You can stop contributing to your RA without being charged penalties
Unit trust-based retirement annuities are transparent, flexible investments which, unlike insurance-based RAs, allow investors to completely customise their contributions. This means you can set a contribution that is fully aligned with your affordability, and you can adjust the level of contribution upwards or downwards as and when your circumstances change. You can choose to contribute monthly, quarterly, bi-annually or annually, with the added advantage that you can make ad hoc lump-sum contributions whenever your like. This makes RAs very attractive for those who earn an irregular income, or who earn intermittent commissions or bonuses.