The pros and cons of having multiple retirement annuities

Retirement annuities are extremely tax-efficient vehicles for those wanting to save towards their retirement and, while tax efficiency is often touted as their main advantage, it should not be the only factor considered when investing through this type of vehicle. Retirement annuities (RA) can be used to serve a range of purposes in one’s overall financial portfolio and, as such, should be used strategically to achieve those goals. Further, while consolidating one’s retirement investments through a single RA may have certain advantages, there may be value in contributing towards more than one RA. If you’re unsure whether to retain your existing RA or take out another RA, here’s what to consider:

The type of RAs you currently have in place

Old-school, insurance-based retirement annuities generally have quite inflexible structures with higher investment fees and can include heft penalties should you need to change the terms of the contract. On the other hand, unit trust RAs provide greater investment flexibility, more cost-effective fees and no cancellation fees or penalties should you wish to pause or adjust your contributions at any stage. As such, if you are currently contributing towards an old-school retirement annuity and have not maximised your tax-deductible contributions, it may be worthwhile opening up a unit trust retirement annuity as an alternative. As a word of caution, do not cancel your old RA before first understanding what penalties or fees are involved. Your financial advisor can assist you with obtaining this information from the insurance company and prepare a cost-benefit analysis to determine the most appropriate course of action.

Your liquidity needs in retirement

There are inherent risks in housing all your retirement funding capital in compulsory investment structures such as pension funds and RAs, specifically when it comes to accessing capital after formal retirement. As such, it is important to carefully assess any potential capital outflows in retirement such as the costs of overseas travel, home renovations or vehicle upgrades, as well as your emergency funding requirements. Before committing all your investment contributions towards compulsory funds, be sure you have carefully assessed your cash flow needs in retirement to ensure that you don’t run into liquidity problems later on. Finding the balance between investing in the most tax-efficient manner while also ensuring liquidity takes careful planning.

Estate planning considerations

The type of structure that your funds are invested in can impact your estate planning and it’s important to take this into account before setting up another RA. Remember, the funds invested in your retirement annuities do not form part of your deceased estate and, in the event of your death, will be distributed in terms of Section 37C of the Pension Funds Act to those who are deemed to be financially dependent on you (in whole or in part) at the time of your death. This means that, while you are able to nominate beneficiaries to your retirement annuities, the final distribution of the death benefits rests in the hands of the fund trustees. On the other hand, money held in a discretionary investment will be distributed as per your wishes. As such, it is important to take your broader estate plan into account before taking out an additional RA.

Investment flexibility

It is important to keep in mind that any funds invested in an approved retirement fund (such as your pension fund and retirement annuities) are subject to the limitations set out in Regulation 28 of the Pension Funds Act which places certain limits on your investment’s exposure to riskier assets such as equities and offshore assets. On the other hand, should you invest towards a discretionary investment such as a LISP (unit-trust-type investments offered by ‘linked investment service providers’), you have full investment flexibility and can construct a portfolio entirely aligned with the investment returns you require and your propensity for risk. As such, before taking out another retirement annuity, it is important to understand what investment returns you will need to achieve to reach your retirement goals together with your investment horizon.

Your income needs in retirement

As mentioned at the outset, there are benefits to have multiple retirement annuities in place, although the decision should be made strategically with a long-term view of your retirement plan. Remember, when retiring from an RA, you are required to use at least two-thirds of the investment to purchase an annuity income either in the form of a life annuity or a living annuity, or a combination of both. If you set up a living annuity, you can only adjust your drawdown rate each year on the policy’s anniversary, which can be somewhat restrictive. One significant benefit of having multiple retirement annuities in place is that you can stagger your respective retirement dates which, in turn, will give you the equivalent number of opportunities in each tax year to adjust your drawdowns – thereby providing you with some income flexibility in your retirement years.

The status of your existing retirement annuities

Another factor to consider before taking out an additional retirement annuity is whether or not your existing RA enjoys what is referred to as ‘grandfathered’ status which effectively means that it is exempt from complying with the provisions of Regulation 28 of the Pension Funds Act. Those retirement annuities that were taken out before 1 April 2011 (when Regulation 28 became effective) are not required to comply with the investment limitations imposed by this piece of legislation. However, if material changes – such as a contribution increase – is made, the investment will need to comply with Regulation 28 which can, in turn, impact on your investment returns over the longer-term. As such, if you want to make additional contributions towards your retirement funds, increasing your contributions to a ‘grandfathered’ RA will have the effect of triggering compliance to Regulation 28, and it may be more appropriate to set up an entirely new retirement annuity.

As is evident from the above, while reducing one’s tax liability is an important consideration, there are multiple other factors involved when structuring one’s retirement funding portfolio, and our advice is to seek the guidance of an independent financial advisor.

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