There has been much debate around the real advantages of investing in a retirement annuity. Many detractors argue that the tax payable on the subsequent compulsory annuity income negates the tax deduction benefits of RA contributions. Numbers, however, don’t lie – and this analysis serves to show the unmistakable benefits of investing in a retirement annuity.

For the purposes of this exercise, we have used the example of two investors, Amanda and George, who are both age 35. They both earn an income of R50 000 per month, netting an amount of R37 269 after tax in accordance with the current tax tables. Both Amanda and George are able to invest an amount of R10 000 per month.

Amanda chooses to invest her R10 000 per month towards a unit trust-based retirement annuity, whereas George elects to invest into a discretionary unit trust portfolio. In preparing the examples below, we have assumed that real investment returns for both Amanda and George are set at inflation plus 4%. For a list of all further assumptions made in preparing this analysis, please see below.

• The accumulation phase

Amanda’s investments

Because Amanda invests an amount of R10 000 per month towards a retirement annuity, she receives a tax refund from SARS every year of R44 532. To boost her retirement savings and to ensure liquidity in retirement, Amanda invests this refund every year into a discretionary unit trust portfolio. After 30 years, her investments in today’s terms are as follows:

George’s investments

George invests his R10 000 per month into a discretionary unit trust portfolio and does not receive any tax rebate. After 30 years, he has the following amount in today’s terms invested:

At retirement, Amanda has 37% more in her investments than George.

• At retirement

At retirement, Amanda is permitted to withdraw up to one-third of the capital in her RA. She is obligated to purchase a compulsory annuity with the remaining funds. She can also elect to use the full amount to purchase a living annuity.

Amanda’s investments

To be tax-savvy, Amanda elects to only withdraw R500 000 from her retirement annuity tax-free and re-invest these funds into her discretionary unit trust portfolio. She purchases a compulsory living annuity with the balance remaining in her RA. Her investments at retirement are therefore as follows:

As Amanda is age 65, she only pays tax on the amount over R10 191 per month. Taking her objectives into account, Amanda will be able to draw an after-tax income of R35 000 per month in today’s terms from her investments, increasing annually at a rate of 6%, until she reaches age 90, without experiencing any liquidity problems. At age 90, her capital will be depleted.

George’s investments

Because George has invested in a discretionary portfolio, he is not obligated to purchase a living annuity. His funds therefore remain in his unit trust portfolio:

George has less invested capital than Amanda, and as a result he is only able to draw a net post-retirement income of R29 000 per month in today’s terms, increasing annually at a rate of 6%, until age 90. We have assumed that George’s portfolio is structured in order to avoid paying dividend’s tax and CGT.

• The advantages of Amanda’s RA

After 30 years of equal investment premiums, Amanda will have amassed 37% more in invested capital than George. Because Amanda has made optimal use of her retirement annuity over a 30-year period, she is able to draw 21% more retirement income than George. This example demonstrates how the mechanics of a retirement annuity, if used as a long-term investment vehicle, can benefit an investor as follows:

• The investor can save tax by investing into an RA and benefiting from higher SARS tax rebates;
• At retirement, the investor is permitted to withdraw R500 000 tax-free from her RA, which also benefits the investor by creating future liquidity;
• Amanda was able to withdraw R500 000 tax-free from her RA at retirement

For the purposes of this analysis, we have kept the examples relatively simple in order to demonstrate the mechanics and advantages of a retirement annuity. However, this example demonstrates how, if used optimally, a retirement annuity can significantly boost your retirement savings despite tax being paid on living annuity income.

In our next series of articles on RAs, we will explore the use of low-cost ETFs and other discretionary investment vehicles as a means for retirement funding. We will also look more closely at how Regulation 28 impacts on investment returns, and how Capital Gains Tax impacts one’s retirement funding if investing through a discretionary portfolio.

Assumptions

* CPI is assumed at 6% per year

* Investment premiums will increase annually at a rate of 6%

* SARS tax rebates will increase annually at a rate of 6%

* For the sake of simplicity, we have assumed real investment returns on all invested assets to be inflation plus 4%

* Life expectancy of age 90 is assumed

* Personal tax rates as per the 2019/2020 tax tables apply

* Retirement age of 65 is assumed

* No annual escalation on investment premiums is assumed

* We have assumed no tax bracket creep over the investment period