Spring – the season of new beginnings and fresh perspectives.
It is always inspiring for me to see people dive into their gardens with gusto, weeding furiously, throwing topsoil and pruning eagerly in preparation for the first spring rains. Exercise outfits are also dusted off around this time of year with people taking to the streets and gyms to get the blood flowing and exercise juices moving!
Spring reminds me of New Years’ resolutions as people seem to have renewed energy and a desire to improve their lives. A time to reflect on what’s important and to implement plans to ensure that priorities are given the correct attention.
So while “spring enthusiasm” is rife, why not add another item to your to-do list – springtime investing!
September is a great month to review your investments and give them a good old spring clean ahead of the year-end holiday rush – which tends to break the bank somewhat. We all invest for various purposes but our ultimate goal should be to build up enough money to provide for our retirement years, the years when most of us want to relax and take things easier!
One of the most important actions that people should undertake over their lifetime is investing towards their retirement. Typically pension, provident, preservation and retirement annuity funds are the vehicles used to help with your retirement funding. Collectively these are referred to as retirement funds and when used smartly are excellent tools that create wealth for your “relaxed” years.
What is the difference between retirement funds and how can I use them to secure my retirement?
Before answering this question it is worth noting that there were some legislative changes made to retirement funds that took effect on 1 March 2021. Two new terms called vested and non-vested rights were introduced which specifically apply at retirement. These rights determine the amount of cash that one will be able to access from retirement funds at retirement, subject to taxation of course.
If you reach retirement and are a member of a retirement fund that has vested rights, then you can have the entire amount of your retirement fund value paid out to you in cash, subject to tax. It is extremely important to understand the tax implications before opting for all the cash.
You don’t have to take the entire vested rights fund value in cash, however, any amount not taken in cash (subject to tax) must be used to purchase an investment, known as an annuity, to provide you with an income for life. The two most popular annuity types to assist with an income at retirement are guaranteed annuities (life annuities) and living annuities.
If you reach retirement and are a member of a retirement fund that has non-vested rights then you can have up to a maximum of 1/3rd of your retirement fund value paid out to you in cash, subject to tax. The remaining 2/3rd of the non-vested right must be used to purchase an annuity, to provide you with an income for life. Similarly, you don’t have to cash out the entire 1/3rd, you can choose any amount (not more than 1/3rd) or even take no cash and use the entire amount to purchase an annuity.
Pension and provident funds
When you join a company that offers a retirement fund you will find that they either have a provident or pension fund in place. As part of your terms of employment, you would be compelled to join the company retirement fund (pension and/or provident). You and your employer make contributions to the company retirement fund and all these contributions are tax-deductible. Your company chooses the retirement fund provider and fees applicable and hence your choices are limited to those set out by your company and their chosen retirement fund provider.
You can access the company’s retirement fund when you:
- Reach retirement as per your company’s retirement rules and access cash depending on the vested and non-vested rights applicable.
- Resign, are retrenched or dismissed and have the money paid out to you in cash subject to tax – this is not always advisable and could prove costly from a tax perspective as well as destroying your retirement capital provision.
Vested and non-vested rights introduced some complexity primarily to provident funds that one needs to understand. Prior to 1 March 2021, all contributions (employer and employee) made to a provident fund were seen as vested rights. After 1 March 2021, all contributions to P=provident funds are seen as non-vested rights. After 1 March 2021, a provident fund can have vested and non-vested rights. If a member of a provident fund was 55 years or older at 1 March 2021, and remains in the same provident fund, all contributions will be seen as vested rights even after the 1 March 2021 date.
Prior to and post 1 March 2021 all contributions to pension funds are seen as non-vested rights and hence the new legislative change had no direct impact on pension funds.
Where vested and non-vested rights become important is when you leave your employer’s fund (at retirement or if you transfer to a another retirement fund) as these rights will determine the amount of cash you can take at retirement, subject to taxation, and how much you are compelled to use to purchase an annuity for life as mentioned.
When you leave your company for reasons other than normal retirement (resignation, dismissal, retrenchment) you are able to transfer to a preservation fund and preserve the value that you have built up. There is no tax applicable when transferring from one retirement fund to another. All vested and non-vested rights accompany the transfer from your company retirement fund(s) to the preservation fund.
You cannot make any further contributions to a preservation fund, however, you are able to make a once off full or partial withdrawal from a preservation fund before the age of 55, subject to taxation.
You can retire from a preservation fund any time after the age of 55 and the amount of cash you can access will be determined by the vested or non-vested rights applicable.
A retirement annuity (RA) is a wonderful retirement investment vehicle giving you a ton of control!
You have freedom and flexibility to choose your own RA which is not subject to certain restrictions as there might be when belonging to a company retirement fund with regards to choice. You don’t have to leave your RA or transfer it every time you change employers or jobs. It is an investment that you chose and control without employer involvement. Hence you can shop around and find one with the lowest fees and investment funds that suit your needs.
You can only retire from an RA after the age of 55 and depending on the vested and non-vested rights you can access a certain portion in cash and must use the balance to purchase an annuity for life.
Similar to pension funds the introduction of vested and non-vested rights had no direct impact on RAs. However, if you leave your employer’s retirement fund(s) and transfer this to a RA there could be vested and non-vested rights components that would now apply to the funds transferred into the RA, normally if the source fund was a provident fund.
All contributions to an RA are tax deductible.
As mentioned, vested and non-vested rights do apply to an RA, but generally RAs will predominantly have a larger (if not all) non-vested rights component, meaning the maximum you can take in cash at retirement is 1/3rd subject to taxation.
Always seek proper financial advice when it comes to any retirement fund to ensure you make an informed decision and understand the mechanics with regards to these funds and how you can best benefit from them.
Here are six themes to tackle when spring cleaning your retirement funds:
1. Your EAC
Do you know all the fees and costs that you are paying towards your retirement funds? Costs have a huge impact on investment outcomes over time. Poor management of fees can literally cost you a ton of money over time.
The Effective Annual Cost (EAC) allows one to compare the charges across different investment providers in order to assist investors in making an informed decision. Ask for your EAC from your various retirement fund providers and know how much you are paying. For more about the EAC click here.
2. Your investment funds
Do some homework and understand the investment fund (e.g. a unit trust) in which your money is invested within your retirement fund. Have a look at the asset allocation, the fund objective, performance history and risks involved. These investment funds drive your outcomes, they are the heart of your retirement fund and will ultimately determine your investment success or failure over time.
3. Vested and Non-vested Rights
Do you understand how your retirement fund works and when you will be able to access cash and how much? Understanding vested and non-vested rights is important from the get go so that you ensure that when you reach retirement you know just how much you can take in cash, how much tax you pay and how much you need to invest to help generate an income for the remainder of your life.
Don’t assume you can access your entire fund at retirement rather seek clarity now to avoid any nasty surprises later.
Check if your retirement fund is well regulated and what laws are in place governing retirement funds. One such law is the Pension Funds Act that sets out all the dos and don’ts for your protection.
5. Tax efficiency
Are you taking full advantage of tax concessions by contributing to your retirement funds? Find out how much you can contribute in a tax year (1 Mar to 28 Feb) to maximise your tax planning. You can even get money back to help pay for a well-deserved holiday sometime.
- Contributions and escalations
Are you contributing enough to your retirement fund to be able to provide you with a capital amount sufficient to take care of you in your retirement years? Gather some projections and estimates to understand just how much you can expect at retirement based on your contributions to your retirement fund. Also ensure that you increase (escalate) your retirement fund contributions annually to keep up with inflation.
NB – If you only contribute a small percentage of your income to a retirement fund then you should also expect a small amount at retirement. Having a retirement fund in place does not necessarily mean your retirement is sorted, the amount you contribute and the investment fund chosen are key drivers of retirement success!
No matter what retirement funds you hold – give them a spring clean!
Get into the nitty gritty and make sensible fresh changes to ensure you are maximising your retirement funds. After all you are ultimately responsible for your retirement plans and only have one chance to get it right. The earlier you start the better.