Let's have a look at the facts
Retirement annuities have come under scrutiny lately, mostly because of the government’s intention of reimposing ‘Prescribed Assets’ (which I have covered recently in a blog you can find HERE). Some authors and financial planners have gone as fa as to recommend that you retire from your RA immediately at age 55 because Living Annuities are not restricted, and you can have 100% offshore exposure.
Let me just take a step back and remind you of some of the important points on all retirement funds. At the moment you can contribute 27.5% of your income (more than just salary) up to a maximum of R350k per annum (R1.272m income pa). Let’s look at someone earning R50k per month, the marginal tax rate is 39%. They can make R165,000 in retirement fund contributions per annum. These contributions are tax deductible, and will result in a refund of around R64,000. That is not insignificant. If you invest that refund your R165,000 investment is now R229,000. Even a stock market that is flying is going to give you that sort of return in a year. Retirement contributions are one of the only tax allowances left for salaried employees, it is almost a no-brainer to use it.
Retirement funds and annuities are not estate dutiable. The R3.5m per person estate duty abatement hasn’t increased since 2007! When capital gains tax (CGT) was introduced in 2001, there were lofty intentions to have CGT replace Estate Duty. 20 years later CGT keeps on creeping up and Estate duty rebates erode in real terms. If you potentially have a huge estate duty bill in the future, putting excess funds into formal retirement savings as a legacy for your children, even if you’ve actually retired, is not the worst idea in the world.
Flexible investments outside of retirement funds regulated by the Pension Funds Act, are taxed on interest, yield, and CGT. Sure, there are some small annual allowances, but thereafter you’re going to be taxed at your marginal rate. Within pension fund investments there is no tax. In other words, if you have a Flexible Investment and an RA with exactly the same contributions, the RA will do better, purely because of the fact that none of the yield or growth is taxed.
What to consider
There are some caveats when it comes to RAs. Always use a LISP platform (not an insurance platform), never accept upfront fees and take a magnifying glass to all the other fees. Pick low fee Unit Trusts or ETFs and shy away from ‘performance fees’. Have a look at the EAC – Effective Annual Cost. You need to keep these under 1.5% if you can.
How can you tell if your investment is win-win? Take inflation currently 3.2%, but realistically probably 4%. Add your ‘EAC’ – say 2.5% (about average). That is 5.5%. You, the investor, will only start to win once your investment has made more than 5.5% pa. On insurance platforms it is not unusual to see an EAC of 5% or more.
When you ‘retire from’ the RA you can take 1/3 as a tax-free lumpsum, and the first R500k (lifetime amount) is tax-free. Thereafter it is taxed at an incremental rate, starting at 18% (and going up to 27%, ad 36%). Before you dismiss 18% being lost from your lumpsum as irrelevant or ‘worth it’ just to get it out of the government’s prescribed asset hands, do the Maths. It will take your ‘liberated’ investment years to make that up. One of the arguments out there is that you’ll make it up on the depreciation of the Rand by having full offshore exposure. The Rand is one of the most volatile currencies in the world, and we have most defiantly not covered ourselves in glory in the last 5 years with a stagnant stock market and an average 5% depreciation of the Rand per year over those 5 years. This is likely to continue because there are no signs of this government having the wherewithal to overhaul government spending of your tax-payer funds.
What should you do?
Make no mistake, I am extremely concerned about Prescribed assets, but I think you should wait and see – and ask questions. What sort of return will they offer? How does this compare to the rest of the market? Are there guarantees?
The other 2/3 of the retirement funds must go into a ‘compulsory annuity’ which can be paid out between 2.5% and 17.5% per annum. If you want that annuity to last the whole of your life, you shouldn’t draw down more than 4.5%-5% pa. That is treated as income by SARS and will be taxed. If you’re 55 and still working, hopefully at the best income level you have ever enjoyed, what is the sense in now adding more income which will be taxed at the marginal rate? In the case we looked at at the beginning of this blog (R50k pm), you’d lose 39c out of every Rand you are now getting as ‘retirement income’. If we had the choice of taking no income it would be different, but there is no indication now that the government will entertain that idea (although it has been floated once or twice).
In short, prematurely retiring from your RAs could have a significant financial impact on your long-term financial security so make a logical, not emotional decision.