As investors rush to top up their retirement annuities so as to maximise their tax savings, first-time investors may feel somewhat overwhelmed by the options available to them. If you intend to set up a retirement annuity before the end of the 2022/2023 tax year, here are some guidelines to follow.
- Calculating your taxable income: To maximise the tax benefits of a retirement annuity you will need to calculate your taxable income so that you can determine the appropriate level at which to contribute. Legislation permits investors to contribute up to 27.5% of taxable income per year towards an approved retirement fund on a tax-deductible basis, subject to an annual maximum of R350 000. When determining your RA contribution, be sure to accurately calculate your taxable income by taking all sources of income into account including bonuses, overtime, allowances, rental income, and dividends earned from REITS. Once calculated, you will be in a position to determine the most tax-efficient contribution level.
- Balancing your investment portfolio: One of the key features of a retirement annuity is that – subject to a few exceptions – you cannot access your funds before the age of 55. This means that while you may be tempted to contribute the maximum tax-deductible amount, it is important to understand the longer-term implications of locking your money away. While retirement annuities are great for helping you achieve your longer-term investment goals, be sure to give thought to your short- to medium-term investment goals which may be better served through discretionary investing. The idea is to create a workable, tax-efficient balance between compulsory and discretionary investing while at the same time being true to your lifestyle goals.
- Unit trust versus insurance-based RAs: When selecting the type of RA you wish to invest towards, it’s imperative that you understand the difference between a unit trust-based RA and an insurance RA. Historically, the majority of retirement annuities were policies sold by insurance companies to policyholders, with the terms of such policies being fairly restrictive, inflexible and containing considerable commissions payable to advisors who sold such policies. These types of policies were often complex and expensive, and investors were penalised for cancelling their policies early. On the other hand, newer-generation retirement annuities that are housed on a LISP platform provide investors with full transparency, cost-effective fees, and flexibility when it comes to selecting the underlying investment strategy and structuring an appropriate contribution plan.
- Understanding the impact of Regulation 28: While RA investors have a fair amount of flexibility when it comes to choosing an investment strategy, it is important to remember that your RA is governed by the Pension Funds Act and in particular, the restrictions imposed by Regulation 28 thereof which, although more lenient than in the past, restrict exposure to riskier asset classes within an RA structure to protect investors against poorly diversified investment portfolios. That said, it is just as important to understand what investment fees you will be charged, whether or not they are market-related, and how they impact on your investment returns over the longer term.
- Selecting a multi-manager: If selecting a fund or combination of funds is overwhelming, you may want to consider using a multi-manager. Asset management and the selection of underlying unit trusts require an enormous amount of expertise and skill, and a multi-manager approach has proven to be of huge value to many investors. The role of the multi-manager is to actively research and assess the various funds, and to select a blend of fund managers for your portfolio. They actively manage the process of re-balancing your portfolio and re-calibrating it in line with your specific investment mandate. Due to economies of scale, you will find that many multi-managers can provide competitive investment fees.
- Your RA in the context of your estate plan: Retirement annuities can be great estate planning tools although there are some limitations that investors should be aware of. A notable advantage of investing in an RA is that the funds fall outside of your estate and will therefore not be taken into account by the executor of your deceased estate when calculating estate duty or executor’s fees. Further, the funds held in an RA structure are protected from your creditors in the event that you become insolvent. However, when it comes to leaving a financial legacy for your loved ones, your estate planning intentions may be limited by Section 37C of the Pension Funds Act which dictates how your RA death benefits should be dealt with in the event of your passing. This section aims to ensure that, should you die before retiring from your RA, the funds will be distributed amongst those who are financially dependent on you. So, while you can nominate beneficiaries on your RA investment, it is ultimately the trustees of the fund who are tasked with distributing the funds amongst your financial dependants. This means that those people you would like to benefit from your RA may not be the same as those determined by the fund trustees.
- Maximising your tax benefits: When submitting your tax returns, you will need to include all tax-deductible expenses for the year of assessment, including the contributions you made to your RA. At the end of the tax year, your RA provider will provide you with a retirement annuity contribution tax certificate as proof of your investment which SARS will then use when determining your tax refund. Rather than view your tax refund as a financial windfall, think carefully in advance about how you intend to use this money most effectively. For instance, you may want to park the money in your access bond so as to reduce your monthly bond repayments or use it to bring your emergency fund to a more adequate level. If you’re not contributing the maximum tax-deductible amount towards your RA, you may even consider using this capital to make an ad hoc contribution towards your RA.
- Timeous administration: If you intend setting up a retirement annuity before the end of the tax year, keep in mind that you will need to begin the process as soon as possible to ensure that the funds reflect with your service provider before the deadline. You will need to complete the application relevant to the investment platform or multi-manager you have chosen and provide all necessary personal information including the level and frequency of your contributions. Remember, with a unit trust-based RA you are free to stop and start your contributions as and when necessary, without fear of any penalties or fees being charged. Your financial advisor should be able to advise you on a reputable service provider and facilitate the process of administering the set-up of your RA.
Once your RA has been set up and the funds reflected with your chosen service provider, your future contributions will be debited in accordance with your instructions. That said, unit trust-based RAs are entirely flexible when it comes to contributions meaning that you can increase and decrease your contributions as and when your personal circumstances change, make ad hoc lump sum contributions, or stop your contributions altogether. Further, if you are not satisfied with your RA’s service, fees or investment performance, keep in mind that you are free to transfer the investment to another service provider without incurring any costs.
Once you have set up your RA, it is advisable to review your investment on at least an annual basis to ensure that you are maximising your tax benefits, contributing at an appropriate level and that your investment strategy remains aligned with your longer-term goals and appetite for risk.
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