With just a couple of weeks left until the end of the 2021/2022 tax year, now is an opportune time to maximise your tax-deductible retirement annuity contributions and take a closer look at how this highly tax-efficient retirement funding vehicle works.
While the long-term benefits of investing through a retirement annuity cannot be overstated, there’s a lot more to this impressive retirement funding structure than meets the eye. Here’s what to know.
Governed by the Pension Funds Act, an RA is an individual retirement fund available to anyone who wants to save for their retirement in a tax-efficient manner. While pension and provident funds are employer-linked funds, an RA has no association with one’s employer group or employment status. As such, employees who contribute towards a company provident or pension fund can use an RA to boost their retirement funding, while those who don’t have access to group retirement benefits can use an RA as their primary retirement funding vehicle.
As an RA investor, you are able to invest up to 27.5% of your taxable income on a tax-deductible basis up to an annual maximum of R350 000, meaning that at the end of the tax year you can claim back the tax in respect of the contributions made towards your RA. Other than your salary, there are a number of other income sources that must be taken into account when calculating your taxable income including rental income, dividends earned from real estate investment trusts, and investment income.
In addition to being able to invest with tax-free money, retirement annuities are exempt from tax on dividends and interest, and no capital gains tax is payable on the growth earned in the investment.
Setting up a retirement annuity is relatively easy and there are few barriers to entry, with the minimum monthly premium for a unit trust-based retirement annuity being in the region of R500 to R1 000. Housed on a LISP platform, modern retirement annuities provide investors with a wide range of unit trusts to choose from, although it is important to bear in mind that the investment risk within a retirement annuity structure is limited by Regulation 28 of the Pension Funds Act. With its primary purpose being to protect retirement investors against poorly diversified portfolios, this piece of legislation limits, amongst other things, the offshore and equity exposure of retirement funds. While Regulation 28, on the one hand, can be considered a hindrance to investment growth, evidence remains clear that the tax benefits of an RA over the longer term outweigh these limitations.
Retirement annuity investors are free to structure a portfolio that is wholly aligned with their objectives, investment horizon, risk tolerance and requisite returns, and in doing so can select underlying funds and asset allocation that are fully customised to their needs.
In addition, if a unit trust-based RA is used, investors can completely customise the way in which they contribute towards their RA which is especially beneficial for commission earners, those who are self-employed, and/or those who earn irregular incomes. Premiums can be set up to run monthly, quarterly, bi-annually, or annually, and can be stopped and/or started as per the investor’s wishes with no penalties or administration charges being levied.
The uncertainty created by the Covid-19 pandemic over the past 22 months or so has demonstrated the mettle of unit trust RAs as many investors effortlessly put their contributions on hold for indefinite periods of time or until times of greater financial certainty.
With the earliest retirement age being 55, investors are not able to access their retirement funds prematurely, with the exceptions being in the case of ill-health and emigration which we discuss further below – and there is no age limit when it comes to retiring from an RA. As such, a retirement annuity should form part of a carefully constructed retirement plan that takes into account the tax implications of withdrawing from your RA, your future cashflow requirements, and any other retirement funding vehicles that you have in place.
If you leave formal employment, transferring your pension or provident fund benefits into an RA is one of the options available to you, keeping in mind that such a transfer will be tax neutral. Another option is to transfer the funds into a preservation fund with the unique advantage to this option being that you can make one full or partial withdrawal from the fund prior to the age of 55 although, on the downside, you may not make any additional contributions towards your preservation fund.
If you opt to transfer your pension or provident fund benefits to a RA, while you cannot make any withdrawals before age 55, you do have the ability to make additional contributions towards your investment. As such, choosing between a preservation or retirement annuity fund structure to house your retirement benefits should be a carefully considered exercise that takes into account your specific set of circumstances.
Retirement annuities certainly have a role to play when it comes to estate planning, although it is important to understand that there are limitations when it comes to beneficiary nomination. Remember, retirement annuities are government-incentivised funding structures, are designed to encourage individuals to save for retirement and, in doing so, alleviate the burden of the state. As a result, retirement annuity benefits must be distributed amongst one’s financial dependants in the event of your death.
The distribution of the fund benefits is strictly governed by Section 37C of the Pension Funds Act to ensure that anyone who is wholly or partially dependent on you at the time of your death is provided for. As these benefits are distributed directly to your financial dependants in the event of your passing, the funds in your RA will not form part of your deceased estate and are not estate dutiable, to the extent that the contributions were tax-deductible. While the funds in your RA are protected from creditors, this protection does not extend to tax owed to Sars and/or maintenance claims.
The funds held in your retirement annuity can form part of your divorce settlement, although this will largely depend on the nature of your marital regime. Where you are married out of community of property without the accrual system after 1984, your non-member spouse will have no claim to your retirement funds as your estates are completely separate. If you are married with the accrual, the fund value of your retirement annuity will be taken into account when determining the accrual. If you and your spouse are married in community of property, your RA benefits will form part of the joint estate which means that each of you will be entitled to a 50% share of the pension interest at the date of divorce. When calculating the pension interest of an RA for the purposes of a divorce settlement, the total amount of your contributions to the fund up to the date of divorce, plus simple interest at the prescribed rate, will be calculated.
If you have plans to emigrate from South Africa, it is important that you understand what your relocation means for your retirement annuity. With effect from 1 March 2021, the concept of emigration for exchange control purposes has been phased out and, if you leave the country to take up permanent residence in another country, you will need to advise Sars that you have ceased to be a SA tax residence. In doing so, you will need to request a tax compliance status (TCS) for emigration before being permitted to transfer any funds abroad.
That said, you will only be able to access the funds in your RA once you have not been a South African tax resident for an uninterrupted period of three years on or after 1 March 2021. The only other circumstance where you may be permitted to access the funds held in your RA prior to the age of 55 is in the event of early retirement as a result of ill-health or disability, although you will need to meet the criteria of permanent disability as set out in the fund rules in order to qualify.
If you’re invested in a unit trust-based retirement annuity, you are free to transfer your investment to another investment house or platform for whatever reason without incurring any costs or penalties. The transfer of an RA is done in terms of Section 14 of the Pension Funds Act and normally takes a couple of months to complete. While legislation permits you to have as many retirement annuities as you like, there is very little purpose in owning multiple RAs. Remember, the 27.5% of taxable income that you are permitted to invest on a tax-deductible basis is calculated as an aggregate across all your retirement annuities and having multiple RAs will require that you keep careful tabs on your investment premiums to ensure that your contributions remain within the tax-efficient level.
Unlike the old, insurance-based RAs, new generation retirement annuities are flexible, transparent, highly customisable, and cost-effective, and remain one of the most attractive options for long-term retirement investing.