With only three months remaining in the 2024/2025 tax year, now is a good time to explore the workings of this highly tax-efficient retirement funding vehicle. The long-term benefits of investing in a retirement annuity are considerable; however, there are many aspects of this funding structure that may not be immediately apparent. Understanding these details can significantly enhance your investment strategy and optimise your retirement savings. Here’s what you need to know about maximising the advantages of retirement annuities.
Governed by the Pension Funds Act, a retirement annuity (RA) serves as an individual retirement fund designed for anyone seeking to save for retirement in a tax-efficient manner. Unlike pension and provident funds, which are employer-linked, an RA operates independently of one’s employment status or employer group. This independence allows employees contributing to company provident or pension funds to utilize an RA to enhance their retirement savings. Additionally, those without access to group retirement benefits can rely on an RA as their primary funding vehicle.
As an RA investor, you can contribute up to 27.5% of your taxable income on a tax-deductible basis, with an annual maximum of R350,000. This means that at the end of the tax year, you can reclaim taxes paid on your contributions to the RA. When calculating your taxable income, it is essential to consider various income sources, including rental income, dividends from real estate investment trusts (REITs), and investment income. Furthermore, retirement annuities enable investments with tax-free money, and they enjoy exemptions from tax on dividends and interest, with no capital gains tax applied to investment growth.
Establishing a retirement annuity (RA) is relatively straightforward, with minimal barriers to entry. The minimum monthly premium for a unit trust-based RA typically ranges from R500 to R1,000. Modern retirement annuities are hosted on a LISP platform, offering investors a diverse selection of unit trusts. However, it is crucial to remember that investment risk within an RA structure is regulated by Regulation 28 of the Pension Funds Act. This legislation aims to protect retirement investors from poorly diversified portfolios by imposing limits on offshore and equity exposure within retirement funds. While Regulation 28 may appear to hinder investment growth, the long-term tax benefits of an RA significantly outweigh these restrictions, providing substantial advantages for retirement planning.
Retirement annuity (RA) investors have the flexibility to design a portfolio that aligns with their specific objectives, investment horizons, risk tolerances, and required returns. This customisation allows them to select underlying funds and asset allocations tailored to their individual needs. Additionally, if using a unit trust-based RA, investors can fully customise their contribution methods, which is particularly advantageous for commission earners, self-employed individuals, or those with irregular incomes. Contributions can be structured on a monthly, quarterly, bi-annual, or annual basis, and investors can start or stop premiums at their discretion, without incurring penalties or administrative charges.
The minimum retirement age is set at 55, meaning investors generally cannot access their retirement funds prematurely, except in cases of ill health or emigration, which will be discussed further below. Importantly, there is no age limit for retiring from a retirement annuity (RA). Therefore, an RA should be integrated into a well-structured retirement plan that considers the tax implications of withdrawals, future cash flow requirements, and any existing retirement funding vehicles.
If you leave formal employment, one option is to transfer your pension or provident fund benefits into an RA, which is a tax-neutral transfer. Alternatively, you may choose to move your funds into a preservation fund, which has the unique advantage of allowing one full or partial withdrawal before age 55. However, a significant drawback of a preservation fund is that you cannot make any additional contributions going forward.
If you decide to transfer your pension or provident fund benefits to an RA, while you are unable to make withdrawals before reaching age 55, you do have the flexibility to make additional contributions to your investment. Consequently, the decision to house your retirement benefits in either a preservation fund or a retirement annuity should be a carefully considered process, taking into account your specific circumstances and retirement goals.
Retirement annuities play a significant role in estate planning, but it is essential to recognise the limitations regarding beneficiary nominations. These government-incentivised funding structures are designed to encourage individuals to save for retirement and, consequently, reduce the state’s burden. As a result, retirement annuity benefits must be allocated among your financial dependants upon your death. The distribution of these benefits is strictly governed by Section 37C of the Pension Funds Act, which ensures that anyone who is wholly or partially dependent on you at the time of your death is adequately provided for.
Importantly, since these benefits are distributed directly to your financial dependants, the funds in your retirement annuity do not form part of your deceased estate and are not subject to estate duty, provided that the contributions were tax-deductible. While the funds in your RA are safeguarded from creditors, this protection does not extend to taxes owed to SARS or maintenance claims.
The funds within your retirement annuity may be included in your divorce settlement, but this is largely contingent on your marital regime. If you are married out of community of property without the accrual system established after 1984, your non-member spouse will not have a claim to your retirement funds, as your estates are entirely separate. Conversely, if you are married with the accrual system, the value of your retirement annuity will be considered in the calculation of the accrual. In a marriage in community of property, your RA benefits are part of the joint estate, entitling each spouse to a 50% share of the pension interest at the time of divorce. To determine the pension interest of an RA for a divorce settlement, the total contributions made to the fund up to the date of divorce will be calculated, along with simple interest at the prescribed rate. Understanding these nuances is crucial during divorce proceedings.
If you are invested in a unit trust-based retirement annuity, you have the flexibility to transfer your investment to another investment house or platform without incurring any costs or penalties. Such transfers are governed by Section 14 of the Pension Funds Act and typically take a few months to finalise. Remember, the 27.5% of taxable income you can invest on a tax-deductible basis is calculated collectively across all your retirement annuities. Therefore, managing multiple RAs requires careful tracking of your investment premiums to ensure your contributions remain within the tax-efficient limits.
Unlike the old, insurance-based RAs, new-generation retirement annuities are flexible, transparent, highly customisable, and cost-effective, and remain one of the most attractive options for long-term retirement investing.
Have a fabulous day.
Sue
