Retiring from your RA: What happens next?

Retirement annuities fall within the ambit of pension fund legislation and, as such, are heavily regulated. Understanding your reasons for investing in a retirement annuity, and what happens when you retire from the fund, is paramount to getting your portfolio structuring right.

Other than in the case of emigration or early retirement as a result of ill-health, you are permitted to formally retire from your RA from age 55 onwards. At retirement, you have the option of withdrawing one-third of the funds in your RA, with the first R500 000 of the withdrawal being exempt from tax. If the total value of your RA does not exceed R247 500 you are permitted to withdraw the full amount tax-free. The balance of your one-third withdrawal will be taxed as per the retirement tax tables. The remaining two-thirds of your investment must be used to purchase an annuity (or pension) income in the form of a life or living annuity. If you do not opt for a withdrawal at retirement, you will need to use the full balance in your RA to purchase an annuity.

Choosing whether or not to make a lump sum withdrawal from your RA and choosing an appropriate annuity to provide for your retirement are important decisions that can have far-reaching consequences if made incorrectly. There is no one-size-fits-all solution when it comes to retiring from an RA and, together with your adviser, you will need to develop a retirement plan that suits your personal circumstances.

Inflation and longevity – the risk of out-living your capital – are considered two of the greatest retirement risks, and effective retirement planning means mitigating these risks as far as possible. In essence, inflationary risk is the risk that inflation will be higher than expected which can diminish the purchasing power of your income over time. On the other hand, longevity risk is the risk that you will outlive your invested capital. It is always difficult to make longevity assumptions and, as such, it is safer to assume you will live a long life. The type of annuity that you choose can determine the extent to which these risks are mitigated.

When determining whether or not to withdraw any funds from your RA, you will need to take into account factors such as whether you have debt, the interest you are paying on that debt, any large capital expenses or large purchases post-retirement, as well as your monthly cashflow needs. Legislation currently permits living annuity owners to draw from their investments between 2.5% and 17.5% of the value of the investment per year, and investors can elect these payments to be made monthly, quarterly or annually. Your rate of draw down can be changed annually at the anniversary of your investment’s inception. These regulatory restrictions on the amount you can draw from your living annuity can potentially lead to cashflow problems as the value of your fund diminishes over time. A detailed post-retirement cashflow analysis will highlight any future cashflow problems and help you determine the optimal lump sum withdrawal from your RA at retirement. Investing the lump sum withdrawal from your RA into a discretionary investment such as a unit trust portfolio will create post-retirement liquidity and provide you with more income flexibility in your retirement years. Bear in mind that different tax rates apply to living annuity income and income derived from a discretionary investment, and part of your retirement planning exercise will seek to minimise your tax liabilities.

Choosing an appropriate life or living annuity can be a daunting task as there are many factors that need to be taken into account. A life annuity, which is a contract between the insurer and policy holder, guarantees the policy holder an income for the remainder of his life or for a pre-determined period. In general, a life annuity ceases to exist either on the death of the policy holder or at the end of the guaranteed period. Life annuities can be structured as either level or escalating, with escalating annuities naturally being more expensive.

On the other hand, retirees can choose to invest their funds into a living annuity on a unit trust platform. As the owner of the investment, the retiree has freedom to choose an investment strategy that is aligned with his objectives. On death, whatever funds are left in the investment can be bequeathed to his heirs. A significant benefit of a living annuity is that the underlying assets can be invested more aggressively than those of a life annuity contract.

When choosing between a life or living annuity you will need to take cognisance of your marital status, health, your wishes in respect of leaving a legacy, other income streams, as well as the standard of living you wish to sustain.

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