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Can I capitalise on the bear market by doing an RA/LA swop?

Retirement annuities, living annuities – any investment decision should be considered within the requirements of a financial plan.

I’m turning 70 in early 2021. I have a small income to cover us from our SMME [small, medium, micro-sized enterprise]. My tax liability is zero and my debt is zero, other than rates on two properties both owned and fully paid off. I have a retirement annuity (RA) with Liberty that has, until Covid-19, thrown off 6% per annum on average. Its current value is R2.5 million. I had planned to convert to it into a living annuity (LA) in 2021 and then take the 2% drawdown, thus seeking growth until real capital (cash flow required) when we stop our business. 

My question: With the stock market meltdown, Covid-19 and Moody’s downgrade – a ‘perfect storm’ situation – would it be sensible to rather cash out the RA and invest in a living annuity made up of compliant Regulation 28 unit trusts, or otherwise spread across businesses with low debt that should rebound in say 24 months after the Bear leaves, thus capitalising on the low buy-in value of the units in the present market conditions (more units obtained now for same cash as I would receive if I left purchasing until 2021 as originally planned)?

I realise I will now incur small income tax on the drawdown, but my gut feeling is on the ‘upside’, an increase in the value of units purchased during the bear market will far outweigh the tax loss growth element in a RA under my circumstances. 

Another non-layman’s perspective would be very appreciated as this may be a once-off ‘opportunity in the perfect storm’ at my age. I’m sure many others in a similar situation who have paid up RAs sitting with investment companies would be interested in a second option.

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I will start with the assumption that you have a full range of Regulation 28-compliant funds available to you within your Liberty retirement annuity. This means that by switching your selected investment fund to your preferred fund, you will be in the same investment growth position as that of the living annuity option that you are contemplating. As you will then not be forced to draw an income of at least 2.5% per annum of the capital value and incurring the tax liability on it, you will, in fact, be better off leaving the funds in your current retirement annuity structure.

However, if you do not have the same investment fund selection available to you within your current RA, you can consider transferring the investment to another RA fund that does provide you with the required investment fund selection.

This can be done by way of a Section 14 transfer process that enables you to move your investment from one RA fund to another without any tax implications. Before considering such a move, you would need to enquire from your current RA fund if any penalties will be levied on such a move. This could determine whether such a move will be advisable or not.

Another consideration to take into account when deciding on the appropriate action is whether you want to expose yourself to investment funds with a higher investment risk profile than that allowed by Regulation 28.

Briefly, Regulation 28 prohibits retirement funds from having more than 75% of their investments exposed to equities and limits offshore exposure to 30%. A typical Regulation 28-compliant fund that is managed to take on as much investment risk as allowed by this regulation, will have a long-term return expectation of beating inflation by between 5% and 7% before taking into account administration and advice fees.

By retiring from the RA fund and moving the funds into a living annuity structure, you are no longer constrained by Regulation 28 in your investment choice. This means that you can have greater exposure to growth assets like equities and can also have a larger indirect offshore expose than that allowed by Regulation 28. By selecting a long-term growth fund with a 100% risk exposure, you can increase the long-term return expectation of the investment to beat inflation by approximately 7.5% before administration and advice fees.

Once you are in this structure, you are forced to take a taxable income of at least 2.5% per annum. This will negate any possible outperformance of the fund when compared with the Regulation 28-compliant investment that was retained in the RA for two reasons. Firstly, the additional tax liability that you will incur; and secondly, the likelihood of the income that is paid to you not being reinvested in full.

Selecting an investment fund with a 100% risk exposure may also not be an appropriate investment option for you to consider.

Such an investment decision should be considered within the requirements of a financial plan that takes into account your full investment portfolio, your lifestyle goals and your income requirements, as well as your propensity to take on investment risk.

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