Retirement Annuities 101

There has been a lot noted on social media,by many "experts", as to why you should use, or why you should stay away from, a Retirement Annuity (RA).

My intention is to not try and swing you either way, but to hopefully give you a snapshot of what a Retirement Annuity is, the benefits and a possible alternative which nobody is really talking about.

Many of us will live for 30 years beyond retirement age (depending on your consumption of spicy wings & Bernini), so we expect our retirement savings to 'work' for as long as we have worked. With this in mind, the ideal time to start saving for your retirement is with your first pay cheque. A good rule of thumb to allow you to maintain your lifestyle later on is to save 17% of your salary (yeah right...) starting at age 25. If you start later, you will naturally need to save more or consider retiring later. 

So first off the bat, let's put into perspective what a retirement annuity is and where it fits into your financial planning.

What is a Retirement Annuity?

A retirement annuity is a retirement savings product that allows you to invest in unit trusts and gives you tax savings and a measure of protection, but comes with some restrictions.

Reasons to consider an RA

  • Your contributions to an RA are tax deductible (subject to certain limits). This means that you may be taxed on a lower taxable income amount and could receive money back from SARS at the end of the tax year. The income and capital growth earned on your investment until you retire is also tax free.
  • Tax deductions on contributions to RAs are limited to the greater of 27.5% of taxable income or remuneration (excluding any retirement fund lump sum, withdrawal and/or severance benefits) per year, subject to a maximum of R350 000 per year. You can carry any excess contributions over to the following tax year.
  • You can invest a minimum of R500 a month or a once-off lump sum of at least R20 000 if you don't want to make a monthly investment. You can add to your investment at any time with a minimum additional amount of R500. You decide how much to invest and you can stop and restart investing whenever you need to. There are no fees or penalties and no notice periods when you make changes.
  • The restrictions in an RA aim to ensure your money is kept for your retirement and that it is protected from potential creditors, and yourself.

 Your investment is into your choice of Unit Trusts

  • Your investment returns come from the unit trusts you choose. When choosing a unit trust, there is a trade-off between higher potential return on the one hand, and stability and lower risk on the other.
  • When you invest in an RA, prescribed legal investment limits control the maximum exposure that you may have to various asset classes. You can comply by simply investing in a unit trust that already complies or you can choose to invest in multiple unit trusts available via our investment platform - but you must make sure that your combination of unit trusts complies. You can change your selection when you need to.

Access to your investment is limited:

  1. You can access your funds from 55 onwards. The most you can take out in cash is 1/3rd of the capital invested. The rest purchases you an annuity. If the benefit is lower than R247 500, then you can redeem it in full. SPOILER ALERT: you can be taxed on the cash portion.
  2. Upon permanent disability you are treated as though you are retired and the you can access your investment as per point 1
  3. If the RA is below R7 000 you redeem it
  4. If you are emigrating, or if you are a foreigner who was formally working and are now heading back home, you may be able to withdraw your full investment. You will be taxed on your withdrawal. SPOILER ALERT: Government are looking at locking this in for at least a 3 year period where you may not access your investment. This looks likely set for February 2021
  5. Upon death the proceeds are paid to your nominated beneficiaries. Although no executor fees are applicable, there might be other tax (this is a entire article on its own)

A RA is suitable for you if:

  • You are self-employed and are not a member of a pension fund or provident fund.
  • Your employer is not contributing to a pension fund or provident fund on your behalf.
  • You receive variable income which is not taken into account when your contributions to a pension or provident fund are calculated.
  • You want to supplement your existing retirement savings and benefit from tax savings.

Reasons a RA may not be suitable for you

  • You can only access your money after the age of 55, except in certain circumstances, such as if you become permanently disabled, if you emigrate or if your investment is below the minimum requirements applicable at the time
  • **ALERT** Prescribed legal investment limits restrict how much you can invest in certain investments (Regulation 28)
  • When you retire you can only withdraw up to one-third of your investment as cash. The rest must be transferred to a product that can provide you with retirement income

Ok, so you made it this far. Pat yourself on the back for being awake and not having checked Instagram for 7 minutes.

Here are my thoughts on retirement annuities:

  • They have a place in your financial planning, but they are not the only means of saving towards retirement.
  • Yes, they assist you with lowering your taxable income and that money would've gone into a politician's new Range Rover, but the money is still "sticky" and governed by many rules.
  • The tax will get you somehow (either on the cash portion according to retirement tax tables, or when the monies are invested in a living annuity and the income is taxed)
  • You cannot invest the monies into portfolios that do not abide by Regulation 28 of the Pension Funds Act (Go have some fun: National Treasury

So what's the alternative to saving long-term? Well, there is an alternative called a Tax Free Savings Account (TFSA) and many clients are using this strategy alongside their retirement annuities.

Why should I look at a TFSA?

  • Any interest, dividends or capital gains made within the investment are not taxed
  • When money is paid out from the investment, it's also tax free
  • The portfolios are not restricted to Regulation 28 (you can go 100% offshore if you wish)
  • Asset managers cannot attach performance fees
  • The contributions into the TFSA are not tax deductible
  • There is an annual limit of R36 000 per person (anything saved in excess is taxed at 40%!)
  • You can, at the moment, only save up to R500 000 over the lifetime of the investment. This might change, but I think we might hear something out of the Zondo commission before any amendments are made.

How do you decide? Speak to a Certified Financial Planner as they will look at your investment objects, goals, dreams, hopes and desires and they can assist you with the best strategy.

Sources: Allan Gray, GTC, National Treasury

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