The past decade has seen the rise in popularity of the unit trust retirement annuity – a new generation of retirement investment that offers more flexibility, greater transparency and reduced investment costs. Unlike the traditional insurance RA which took the form of an insurance contract, owners of unit trust RAs are able to invest towards a unit trust portfolio with a number of notable advantages. Whereas insurance retirement annuities were notorious for their distinct lack of transparency and murky performance reporting, unit trust RAs boast intelligible fee and performance reporting together with generous amounts of investment flexibility. With advisors being remunerated on the basis of a professional fee as opposed to an upfront commission (which is effectively borrowed from the client’s future investment with interest), unit trust RAs are enormously cost-effective and worthy of consideration for anyone serious about investment for the long-term.
1. What is a retirement annuity?
As in the case of provident and pension funds, retirement annuities are registered in terms of the Pension Funds Act and are tax-efficient investment vehicles designed for individual investors and employees who wish to supplement their workplace retirement fund. South Africans are permitted to invest up to 27.5% of their taxable earnings towards a retirement annuity on a tax-deductible basis, making it a very attractive investment option. Investors have complete flexibility to determine their own contribution plan – with monthly, quarterly, annual or ad hoc contributions being possible – making it idea for those who earn irregular commissions, incentives or bonuses. With invested funds being inaccessible before age 55, investors can avoid the temptation of dipping into their retirement nest egg prematurely.
2. Who needs a retirement annuity?
A retirement annuity is ideal for anyone who is self-employed or for an employee seeking to supplement the contributions to their workplace retirement fund. For example, if you have an existing workplace pension fund to which you contribute 15% of your taxable income, you would be able to contribute an additional 12.5% towards a retirement annuity – making it a useful tool for those who are behind on their retirement savings. Retirement annuities are great for housing commissions, rental income or interest that is generated over and above one’s pensionable income.
3. How do they work?
Except in the case of ill-health or emigration, investors can only ‘retire’ from a retirement annuity from age 55 onwards, although they are entitled to stop contributing towards their RA at any stage without fear of early termination fees or penalties. There is no maximum age at which you need to stop contributing to your RA or by which you are required to access your funds. Once you decide to ‘retire’ from your RA, you may withdraw up to one-third as a cash lump sum, while the remaining two-thirds must be used towards a compulsory annuity. On death, your RA benefit will be allocated by the trustees of the fund in accordance with your beneficiary nomination, so it helps to list your beneficiaries carefully. Any funds held in an RA are exempt from estate duty and no tax is charged on investment growth.
5. What are the benefits of a retirement annuity?
The following attributes make retirement annuities particularly attractive for long-term investors:
Since 1 March 2016, RAs qualify for the same tax incentives as pension and provident funds. This means that you may deduct your contributions to a retirement annuity up to 27.5% of taxable income for tax, bearing in mind that the 27.5% limit applies to the aggregate of premiums to all the retirement funds that you contribute to, with the overall tax-deductible limit being R350 000 per year. Further, retirement annuities are exempt from tax on dividends and interest, and no capital gains tax is paid on investment growth. At the end of the tax year, you can include your RA contributions on your tax return forms and receive a rebate from SARS. SARS has made it a priority to incentivise South African to make adequate provision for their retirement which is why retirement annuities now offer individuals a number of significant tax breaks.
It goes without saying that high costs have a negative impact on investment growth and that this, in turn, is magnified as costs are compounded over time. Traditional retirement annuities have archaic cost structures which are often difficult to decipher. Unit trust RAs provide a clear breakdown of costs so that the client has full insight into how their money is being invested and what fees are being charged.
While insurance RAs are notorious for their complicated actuarial calculations and lack of feedback regarding investment performance, RAs that are invested in a unit trust portfolio provide fully transparent breakdowns of fund performance and transactions.
Unless you are emigrating or qualify for early retirement due to ill health, you will not be able to access the money in your RA prior to retirement making it a safe haven for money intended for the long-term. Having said that, beware of investing too much into a retirement annuity without keeping enough money accessible in the case of emergency. The key is to find the right balance between saving for retirement and living comfortably in the here-and-now.
Unit trust retirement annuities are flexible by design in that they allow you to structure a portfolio from a selection of underlying unit trusts. You are free to amend your contributions as often as you wish, transfer your investment to another platform or stop contributing altogether – with no costs, penalties, transaction or associated fees being charged.
6. How is my money invested?
Most investment platforms in South Africa offer the solution for a portfolio manager to choose a selection of local and international shares which can be included in your retirement investment and actively managed. As portfolio management and the selection of the underlying unit trusts is a specialist field that requires expertise in investment capability, research and skill, this function can be outsourced to a discretionary fund manager which, because of economies of scale, very often offer competitive investment fees. Bear in mind, however, that any RA is subject to Regulation 28 of the Pension Funds Act which means that you will be subject to certain restrictions in terms of asset classes. Up to 75% may be invested directly in shares, both locally and offshore, with the aim being to ensure your savings are invested in a sensible way and protected from poorly diversified portfolios.
With so many advantages, retirement annuities as long-term, tax-efficient investment vehicles are difficult to ignore and are worthy components of a carefully structured investment portfolio. In trying economic times, channeling funds towards a long-term investment may require some budget manipulation – which is easier to undertake if you consider the ultimate goal of retirement on your own terms and in your own time.
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