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Retirement annuities and compound interest – twice the growth

Forget get-rich-quick schemes; an RA offers incredible benefits that will see your funds grow ever-faster.

The number of opinions on how you should save for retirement are as many as there are people gathered around the braai. Unfortunately, many of these pieces of advice are based on hearsay or tradition, without sound financial planning principals to back them.

Here are some of the regular pieces of advice that I have heard.

Buy property and rent it out

Pros:

An investment that is as safe as houses can surely not go wrong, and you can increase the rent every year to keep up with inflation. If you are still paying the bond, you can subtract any losses against tax and the property itself goes up in value, thereby offering an investment that grows on two fronts.

Cons:

You invest in a rental property with money after tax, which means that your money is worth less than if you were able to invest it before it was taxed. In much the same way your growth in value would be subject to capital gains tax and if your property stands empty for two months or more you will take a year at least to catch up on lost investment growth.

Pay off other debt with that money

Pros:

Credit card debt and other debt can be very expensive, and paying them off will technically save you the interest rate that you would have paid on the debt, which indirectly means that you have saved money at that interest rate.

Cons:

International research shows that over 90% of people return to their old habits and old debt levels after paying off their debt, because their needs and habits do not change. Only now, you are trapped by your debt because you do not have a nest egg to pay it off with anymore.

Play the Lotto, get involved in a get-rich-quick scam or hope for a big break

We all have those dreams and hopes of an inheritance from a long lost rich uncle or a Powerball lucky break, but the reality is that your chances are greater to be eaten by a crocodile and struck by lightning at the same time than to get rich quick. Unfortunately, this dream makes people do silly things, like fall for get-rich-quick schemes that offer overnight riches and then disappears with your hard earned money.

So if these plans are flawed, what is the best way to invest for retirement?

A retirement annuity (RA) offers incredible benefits that will see your funds grow ever-faster, provided that you have the patience to start investing early and keep at it until the day you exchange your business dress for your golf clubs.

Here’s how:

RAs are a catch-all phrase that refers to any investments made for the purpose of retiring. This means that while you have a certain amount invested in RAs, your funds may be divided into stocks, bonds, cash in the money market and other investments.

The benefit of an RA is that you can invest pre-tax money into these funds. This means that your money is worth so much more when you invest it, because you did not have to pay tax at your prevailing tax rate on these funds. In South Africa, you can invest up to 15% of your pre-tax money into investments.

But your tax benefit does not end there. By investing in an RA, you do not have to pay capital gains tax on the fund growth, which becomes available to you after the age of 55. This means that you save double the tax.

An RA is also beneficial, because it does not become subject to the normal estate regulations if you pass away. A house or cash investment becomes locked into a deceased estate until it is sorted out and paid out according to the will, often while being taxed in the process. In contrast, an RA is transferred directly to the family of the deceased as identified in the will, without being subject to the drawn out estate management process.

Lastly, you have the benefit of compound growth. Compound growth means that the rate of growth increases as the funds that have grown in the past increases. To best illustrate this, consider this example:

Compound growth means that the person who starts first will see significantly more growth over the life cycle of his or her investment than someone who starts late.

With that in mind, you should consider the investment in an RA as your first priority, before considering investments in property or other investments.

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ADVISOR PROFILE

Wouter Fourie

Ascor® Independent Wealth Managers

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Methinks we have a RA sales person here! To answer the question “how to save for retirement” – live in a country that offers a decent aged pension, low inflation, decent public healthcare and temperate climate. As regards annuities- I simply cannot believe that a product that has been superseded by better and fairer products elsewhere in the world can still be the “go to” product for sa. The answer is actually very simple – the institutions selling them make loads of money out of them- the govt loves them because of the taxes they bring in – the sales persons love them because of the commissions they bring in. So who is footing the bill -YOU

Finally something I agree with Rob on.

Financial advisors are nothing more than salespeople for the institutions that take your money.

Not to forget that once you’re in an RA you’re there for life and your money ain’t going nowhere until you retire.

NOWHERE.

Great, so you can’t waste your money too much and then have to try to live of a R1500pm pension grant

After 10 years with an RA at Liberty it was worth LESS than what I put in! The consultant told me…”but you need to take a long term view!”. 10 years is a F&*^(* LONG TERM FOR ME!!!
Damn idiots. I then stopped paying into that rubbish. Seems that Liberty makes huge amounts of money from early cancellations of RAs! BEWARE!!!!

They will always spin the “long-term view” BS. It’s part of their marketing blurb.

In reality, they don’t care whether your money goes up or down because they will get their commissions regardless.

Most people also don’t negotiate the fees upfront and end up paying it for the entire duration of their investment.

That is why they really push the RA.

Unfortunately, moving to Australia isn’t an option for most of the people reading this. Even if they meet the point and age requirements to migrate, and then can find a job, the residence requirements are long, and getting longer to qualify for a pension, and political instability because of Australia’s flawed constitution means that the policy goalposts keep shifting.

Therefore the best option is to look for low-cost RA options.

Unfortunately robertinsydney has reason to be concerned about “salespeople & companies” with hidden agendas. It’s very simple: BEWARE of ALL investment products from insurance companies because of concealed commission, high (concealed!) admin costs & early exit penalties.

In respect of tax benefits I support the product 100%.

Extremely important to get proper advice on underlying fund choice because the performance thereof is also vital in outcome.

Unit trust (collective investment) type pruduct is the way to go.

Tax deduction = 27,5% (NOT 15%) of taxable income with a max of R350k per year.

RA is not “transferred directly to the family of the deceased as identified in the will”. The fund trustees have to comply with Sec 37C of Pension Fund Act in order to ensure that DEPENDENTS get paid – not necessarily the nominated beneficiaries.

Lol, now back up with a few stats regarding growth of a few RA’s over lets say 20 years. Me thinks even you would be shocked.

Shocked at how much it has grown compared to the exact same unit trusts outside the RA wrapper because of the no tax?

(50% local equity, 25% local property,25% foreign property and equity, being the main limits)

The tax deductions for retirement savings was increased from 15% to 27.5% as of 1 March 2016.

Wonder if Wouter Fourie is a CFP…
How can a financial advisor give advice without knowing that the max allowable went up to 27.5% 2 years ago.
I assume Moneyweb also does not verify any information being posted.

The correct total is 27.5% for tax deduction.

In my opinion if you are employed by a company that has its own defined pension or provident fund, it would be cheaper to simply increase the contribution to the fund.

As RA policy holder myself, I find these products generally expensive, restrictive combined with low growth.

Good article especially the comments on “the pay the bond off 1st nonsense”.

Start long term savings alongside accelerated bond payments asap.

Agree with Kuduhunter77 on rather increase company contributions to a pension fund but this results in reduced personal flexibility.

As for RISidnee………………guys simply stop responding to him either in comments or votes.

Scary thing is the financial planner of the year still hasn’t picked up the tax deduction increase to 27.5% from 1 March 2016 already.

Very worrying. And it would help his overall impression if he knew the difference between principal and principle.

I completely disagree with everything in this article. Anything that locks your money away is a scam. If you are planning your investments around tax and regulation 40 years into the future you are a brave soul. Im so proud to see millennials shun these old world products. Who says you ever going to see that money? Who says the tax rate wont change tomorrow? who says that the government wont “special tax” your RA in the future when they short, ie Greece and Cyprus? Get your money as far away from the government as possible and look after it yourself. You will surprise yourself how easy it is and how capable you are.

Indeed it is archaic.

He should talk about the tax when it is being drawn.

It’s a solution that works for some. Most don’t stick to the plan and knock it . But – and this is the most important thing – most people don’t save anywhere near enough to retire financially independent. The statistics speak for themselves.

Regulation 28 unfortunately nullify the tax advantage in my view.

A financial advisor that do not address Regulation 28 as part of the argument is not worth his salt. But then again, this specific advisor do not even know about the increased tax deduction rate.

I for one believe you should first max out your Tax Free Savings Account and then see where else.

Asset class performance is also very important. Hence the Regulation 28 liability. Do you as advisor really believe that a 75% allocation to South African assets are giving your client the best growth potential in the medium term? Giving our lower than 1% GDP growth prediction.

Wow read it again. This is horrible. From advice to grammer.

RAs are not pre tax. I knownof very few people who actually save that tax rebate. For one, almost no one know by how much their take home pay is more per month due to their company RA. This is used to gonto Spur once more per month. Secondly, again most spend their tax rebate earned on private RAs.

Then you only swop capital gain (+-15%) and dividend tax (20%) for future income tax at 45% max. Hiw is this tax free? Tax deferred yes, but not Tax Free. Especially if you think that a successful saver’s effective tax rate should be more than CGT and Dividends Tax.

Stop spewing the pre-tax and tax free drivel.

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