If used optimally, a retirement annuity (RA) can be a powerful vehicle for building long-term wealth and securing a comfortable retirement. Being able to invest up to 27.5% of your taxable income on a tax-deductible basis (subject to certain maximum limits) is an obvious benefit of this type of investment vehicle.
However, tax benefits aside, there are numerous other advantages afforded by unit trust RAs which should not be overlooked.
- Investment flexibility: When investing in an RA on a LISP platform, investors have a wide range of unit trusts to choose from allowing both local and international exposure, subject to the limitations set out in Regulation 28 (discussed below). With many RAs, investors can choose their underlying investments and have some flexibility in how their contributions are invested.
- Premium flexibility: RA investors have complete flexibility when it comes to investment premiums. Investors are able to stop and start premiums as they choose without any penalties or fees being charged. Premiums can be set up via monthly, quarterly or annual debit order, or can be paid over manually on an ad hoc basis, making it an ideal investment vehicle for commission earners, business owners or those who earn an irregular income.
- Retirement savings top-up: If you are currently contributing to your employer’s pension or provident fund but not making use of the full 27.5% allowance, you can effectively use an RA to top up your savings. For instance, if you are contributing 15% of your income towards your company’s pension fund, you can use a RA to invest a further 12.5% of income on a tax-free basis.
- No penalties: The fee structure of an RA on a LISP platform is much the same as that of a unit trust investment. All investment, platform and adviser fees are disclosed upfront and, with full premium flexibility, no cancelation or termination fees or penalties of any sort are payable.
- Transparency: Unit trust RAs offer refreshing transparency in respect of portfolio construction, investment returns, fees and reporting.
- Accessibility: While not being able to access the funds in your RA until age 55 may be considered a disadvantage, this mechanism is in fact designed to protect your retirement egg. Knowing that your funds can’t be accessed prematurely, except in the case of ill-health or emigration, provides peace of mind and removes the temptation to borrow against your future.
- Long-term growth: With very few barriers to entry, RAs make excellent long-term investment vehicles. If you begin investing in an RA early in your career, the long-term time horizon will allow you to select more aggressive investment strategies which should provide you with favourable market returns over time.
- Tax exempt: Besides for the tax-deductible premiums, RAs are exempt from tax on dividends and interest, and no Capital Gains Tax is payable on growth earned in the investment. At retirement, investors are also able to withdraw up to one-third of their investment as a lump sum of which the first R500 000 is tax-free. Anything drawn as a lump sum over the R500 000 tax-free portion will be taxed according to the retirement tax tables
- Your estate: A significant benefit of an RA is that it does not form part of your estate. In the event of your passing, the funds in your RA can be paid directly to your nominated beneficiaries to aid them financially after your death.
- No estate duty: As the money in your RA does not form part of your estate, these funds are not subject to estate duty.
- Creditors: Legislation aims to ensure that the money in your RA is earmarked for retirement and is protected from creditors. However, bear in mind that this does not apply to tax owed to SARS and maintenance claims.
- Emigration: If you decide to emigrate from South Africa, legislation permits you to access the full amount invested in your RA, bearing in mind that the withdrawal will be taxed.
- Ill-health: If you are ill and unable to continue working, you may qualify for early retirement from your retirement if you have not yet reached age 55. However, you will need to meet stringent requirements in respect of permanent disability in order to be permitted to retire from your RA.
- Reinvest tax returns: If you are currently contributing towards a retirement, you are likely to receive a tax refund from SARS at the end of this tax year. A great way of re-employing your money and further boosting your retirement savings is to re-invest your tax refund into your RA.
- Ad hoc: Any bonus, inheritance or financial windfall can be injected into your RA on an ad hoc basis, although it is important to calculate the most tax-efficient level of doing this.
Although Regulation 28 of the Pension Funds Act is often considered disadvantageous to investing in an RA, it is worth considering that this legislation is in fact designed to protect investors against poorly diversified portfolios. In terms of Regulation 28, investors in retirement funds are required to limit their equity exposure, whether in South Africa or abroad, to 75%. Investors are also restricted to 25% in local or international property, and 30% in foreign investments.
As investors are required to purchase a life or living annuity with at least two-thirds of their RA at retirement, another important factor to take into account is cashflow planning during your retirement years. Having too much of one’s retirement capital tied up in a compulsory investment may cause cashflow problems and it is important to find the optimal balance between one’s retirement and discretionary investments.
For those who haven’t yet started saving for retirement, the beginning of the new tax year in February 2020 is the perfect time to begin. If you haven’t maximised your 2019/2020 contributions, you have 6 weeks left to do it.