It’s officially retirement annuity (RA) season, when investors are encouraged to make use of their available tax deductions before the end of the 2019/2020 tax year, so as to boost their retirement savings.
Here are answers to some frequently asked questions about retirement annuities:
- Who should invest in a retirement annuity?
A retirement annuity is a suitable long-term investment vehicle for almost anyone wanting to save for a comfortable retirement. Specifically, if your employer does not provide pension or provident funds benefits, a retirement annuity is a great way to invest with tax-free money – subject to an annual maximum of 27.5% of taxable income capped at R350 000 per year. Retirement annuities are also attractive investment vehicles for business owners and those earning irregular incomes, ad hoc bonuses or commissions. If you are currently contributing towards your employer’s pension or provident fund but are not making use of the full 27.5% tax deduction, you can set up a retirement annuity to invest the balance of your tax-deductible premium.
- What is the different between an insurance RA and a unit trust RA?
An insurance retirement annuity is a contractual agreement between the investor and the insurer. The policies typically pay an upfront commission to the advisor and contain a recoupment period of 60 months, from the month of inception, in which a penalty may be applied should you wish to amend the terms of the contract. An example may be a lowering or cancelling of a month premium contribution or a transfer of the retirement annuity to another service provider. On the other hand, a unit trust retirement annuity is an open-ended investment with no recoupment period or penalties applicable. The investor has complete flexibility to raise or lower their contributions and transfer to an alternative service free of any penalties. In both instances the investor can choose his underlying investments, subject to the parameters of Regulation 28, and assumes full investment risk.
- Is there a minimum monthly amount that I need to invest?
Most unit trust platforms in South Africa require a minimum monthly contribution of R500 towards a retirement annuity, making it an accessible vehicle for many.
- What are the tax benefits of an RA?
There are significant tax benefits afforded to RA investors. Investors are permitted to invest up to 27.5% of their annual taxable incomes (subject to the R350 000 per year maximum) into a RA on a tax-deductible basis. In addition to this, no income tax or capital gain tax is charged on the investment returns within an RA. Also, the funds housed in your RA do not form part of your estate, which means that this money will not be subject to estate duty or executor fees. At retirement, investors are permitted to withdraw up to one-third of the value of the retirement annuity(s) of which the first R500 000 of the total withdrawal is tax-free.
- What sources of income can be used to calculate my taxable income?
Other than your salary, there are a number of other income sources that can be taken into account when calculating your taxable income. Rental income, after deduction of allowable expenses, is added to taxable income. Dividends earned from Real Estate Investment Trusts (REITS) are subject to income tax in the taxpayer’s hands and can therefore be included. Gains derived from the realising of capital assets, such as property or discretionary unit trusts, may result in a capital gain. The first R40 000 of capital gain is excluded, and thereafter the gain is added to taxable income. All interest earned in a tax year is subject to income tax. Currently, the first R23 800 per year in respect of those under age 65 and R34 500 for those older than 65 is exempt. All interest earned thereafter is added to one’s taxable income.
- What happens to income earned from living and/or life annuities?
There are a number of reasons you may be receiving an income from a living or life annuity whilst you are still working. For instance, you may have retired early from a fund and receive an income from the annuity, or you may have inherited an annuity from a family member. Income derived from these annuities is taxable and can therefore be added to your total taxable income for the year.
- How many retirement annuities can I invest in?
Investors are permitted to take out as many retirement annuities as they like. However, the tax benefit is calculated in aggregate and not in respect of each retirement annuity. Similarly, the tax-free portion at retirement may only be claimed once.
- When can I access the funds in my retirement annuity?
Generally speaking, an investor can only access the funds in their RA from age 55 onwards, with formal emigration from South Africa and early retirement due to ill-health being two exceptions.
- What happens if I emigrate from South Africa?
In terms of the Income Tax Act, where a South African citizen has formally emigrated from the country and where this emigration has been recognised by SARS, he will be permitted to withdraw the funds from his RA subject to tax.
- Can I stop contributing to my RA?
In respect of a unit trust RA, you can stop contributing to your investment at any time without any fees or penalties. As there is no recoupment period as in the case of insurance RAs, you will not be penalised for stopping or starting your contributions. If you are within the initial 60-month recoupment period of an insurance RA, the insurance company may charge you a penalty for stopping your premiums and making your policy paid-up.
- Can I transfer the funds in my RA?
In general, most retirement annuity funds allow investors to transfer their funds to another retirement annuity. This process will be done in terms of Section 14 of the Pension Funds Act.
- What happens to my RA when I retire?
When you retire from your retirement annuity, you have the option to withdraw one-third of the investment in cash. The remaining two-thirds must be used to purchase an annuity or pension income for your retirement. If you do not wish to make a lump-sum withdrawal, you can choose to purchase an annuity with the full amount. Any cash lump sum taken from an RA at retirement is taxed on the special retirement fund lump sum benefit table. Currently the first R500 000 is tax free with a fixed, banded, tax table applying to amounts over R500 000.
- Can I nominate beneficiaries to my RA?
Yes, you are able to nominate beneficiaries to your retirement annuity. However, in terms of Section 37C of the Pension Funds Act, the trustees of the fund will make the final decision in terms of equitable distribution amongst your dependants and beneficiaries. The trustees will take your wishes into account but are not bound by them.
- Does my RA form part of my estate?
No, the funds in your RA do not form part of your estate when you die. This means that you cannot use your last will and testament to bequeath the money that is housed in your RA. The funds in your RA will be distributed to your heirs and nominated beneficiaries by the trustees of the fund. The money in your RA will not be handled by the executor of your estate and will therefore be excluded from executor fee and estate duty calculations.