Deciding whether to use a compulsory investment, such as a retirement fund, or a discretionary investment depends on several factors, including your investment goals, tax efficiency, liquidity requirements, and long-term financial strategy. While compulsory investments offer excellent tax benefits, they come with limitations on accessibility and investment flexibility, such as restricted access before retirement and investment limits governed by Regulation 28, which may constrain the investor’s ability to pursue higher-risk or more globally diversified strategies. These limitations should be considered in the context of the investor’s overall financial objectives, time horizon, and need for offshore exposure or alternative investments. Conversely, discretionary investments provide more liquidity and freedom of investment choice, but offer fewer tax advantages.
Understanding compulsory investments
Compulsory investments include pension, provident, and retirement annuity funds governed by the Pension Funds Act. These are exceptionally tax-efficient vehicles, offering several long-term advantages to investors beyond immediate tax deductions. You can invest up to 27.5% of the greater of your taxable income or remuneration annually (capped at R350 000 per year) on a tax-deductible basis. Moreover, no tax is payable on growth within these funds—including interest, dividends, or capital gains—and they are excluded from your estate for estate duty purposes, making them useful for estate planning.
Regulation 28 and investment limits
A common concern for retirement fund investors is Regulation 28, which governs how your retirement money may be invested. Its aim is to protect investors from poorly diversified portfolios and excessive exposure to risky assets. As of 2022, Regulation 28 allows up to 45% offshore exposure (including Africa), up to 75% total equity exposure, and up to 25% in property. Alternative investments such as hedge funds and private equity are now also subject to specific limits. While these rules may limit aggressive strategies, they are designed to protect investors from taking on excessive risk and ensure that retirement savings are preserved for their intended purpose.
Access and withdrawal restrictions
Retirement funds are by nature long-term investments. Under the new two-pot retirement system, effective 1 September 2024, all retirement savings are split into three components:
- Vested Pot: This consists of accumulated savings before 1 September 2024 and follows the previous withdrawal rules.
- Retirement Pot: This consists of two-thirds of new contributions from 1 September 2024 onwards and must be preserved until retirement.
- Savings Pot: This consists of one-third of new contributions from 1 September 2024 onwards and allows limited withdrawals before retirement.
In a retirement annuity, funds remain inaccessible until at least age 55, except for withdrawals from the Savings Pot. From age 55, you may retire and cash in up to one third of your funds, subject to the retirement tax tables with the balance used to purchase a living or life annuity. For pension and provident fund members, access depends on the type of savings:
- Vested Pot: Can still be accessed on resignation, retrenchment, or dismissal, subject to previous withdrawal rules and taxation.
- Retirement Pot: Cannot be accessed before retirement—it must be preserved.
- Savings Pot: Can be accessed once per tax year, but withdrawals are limited and subject to marginal income tax.
Living annuities and post-retirement flexibility
One key advantage of purchasing a living annuity with your retirement capital is that it is not subject to Regulation 28, allowing for more aggressive investment strategies, including 100% offshore exposure via Rand-denominated feeder funds. Direct offshore investing is not permitted within a living annuity. Living annuities also allow for beneficiary nominations. Upon death, the proceeds fall outside of your estate and are not subject to Section 37C of the Pension Funds Act. Your nominated beneficiaries can choose to withdraw the funds as a lump sum, transfer them into a living annuity in their own name, or implement a combination of the two.
Drawdown rules and liquidity risk
Investors in living annuities may choose a drawdown rate between 2.5% and 17.5% annually. This rate can be reviewed on the policy anniversary each year. However, if your drawdown exceeds the investment growth rate, your capital will erode over time—potentially leading to liquidity problems later in retirement. Unlike discretionary portfolios, lump sum withdrawals are not allowed, which may leave investors vulnerable to funding shortfalls for emergencies, large purchases, or unforeseen medical expenses.
Why discretionary investments matter
Discretionary investments, such as unit trusts, play an important role in complementing retirement funding. Contributions are made from after-tax income, and investors are liable for tax on interest, dividends, and capital gains. Local interest is taxed at your marginal rate, with exemptions of R23 800 for those under age 65, and R34 500 for those over 65. Dividends are taxed at 20%, and the first R40 000 of capital gains per annum is exempt from CGT. Any gains above this threshold are included in taxable income at an inclusion rate of 40%.
Estate planning considerations
Unlike compulsory investments, discretionary investments form part of your estate and are subject to estate duty and executor’s fees. There are no beneficiary nominations; instead, these assets are dealt with in terms of your Will. This means heirs may need to wait months or even years for access, and the capital may be used to settle estate liabilities. Nonetheless, discretionary portfolios provide essential liquidity during retirement, allowing for flexible cash access when needed for planned or unexpected expenses.
Ultimately, an optimal investment strategy will likely include both compulsory and discretionary investments. The former provides long-term tax-efficient wealth accumulation, while the latter ensures liquidity and flexibility. A blend of both helps protect against liquidity risk in retirement, enhances estate planning, and ensures access to emergency capital when needed. Speak to a qualified financial adviser to ensure your investment structure is well-aligned with your lifestyle, goals, and financial objectives, helping you achieve a balanced portfolio that meets your short-term needs and secures your long-term financial future.
Have an amazing day!
Sue
