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Introduction

We all dream of having a carefree and financially healthy retirement. Unfortunately, for some of us, this dream never becomes a reality. There are a number of reasons for this, including:

  • Not preserving your retirement savings, e.g. when you change jobs;
  • Not achieving the expected investment return on your retirement savings, or fees eroding too much of your retirement savings;
  • Simply not saving enough for retirement during your working lifetime.

It is generally accepted that, in order to receive an adequate post-retirement income, you have to save at least 15% of your annual salary income throughout your career. Of course, the later you start to save towards retirement, the larger this proportion needs to be.

Choosing the correct retirement savings vehicle

So you’ve had a look at your budget and decided that you want to put away 20% of your salary each month to save for retirement. The next question, of course, is what is the best retirement savings vehicle to use?

It is easy to become confused by the myriad investment vehicles available in the market, each of which has its own pros and cons. Therefore, the best place is normally to start by looking at your company’s own retirement fund.

Most companies provide their employees with the opportunity to save for retirement by allocating a proportion of their pre-retirement salaries to the company’s dedicated retirement fund. The money allocated to this fund is deducted from the employee’s salary for taxation purposes, and there is normally a (limited) range of underlying investment options available.

But what if you are self-employed, or if your company’s retirement fund only allows you to allocate a proportion of your salary up to a specified maximum (e.g. you would like to allocate 20% of your regular salary towards your retirement savings, but your company only allows you to allocate up to a maximum of 15% of your salary)?

In this case, a Retirement Annuity could be the answer.

The advantages of the Retirement Annuity

The Retirement Annuity (RA) has the following characteristics which make it the ideal retirement savings vehicle:

  1. The contributions paid into your RA are tax deductible up to a maximum of 15% of your non-pensionable income, so SARS is effectively sponsoring a part of your retirement savings!
    But what is non-pensionable income? Let’s assume for the moment that you are in full-time employment, and you are remunerated by means of a basic salary plus bonuses and commissions. If you are a member of a pension or provident fund and all of your basic salary is pensionable, while your commission and bonus is not pensionable, then you may claim 15% of your commission and bonus as a tax free deduction to an RA.
    However, if you are not a member of a pension or provident fund (e.g. you are self-employed), all your remuneration is non-pensionable, and you may claim up to 15% of your remuneration as a tax free deduction to an RA.

  2. RA investment returns are not subject to income tax, capital gains tax or dividend tax. This means that no matter how much you gain in terms of investment returns, you will not be taxed on any of these gains.
  3. The lump sum payout at retirement (a maximum of one third of the accumulated benefit) or on death may be tax-free within certain cumulative limits that apply to lump sum payouts from all retirement savings vehicles, which is currently R315 000.
  4. On death, any benefits paid out from an RA, are free of estate duty.
  5. Part of your RA can be used to cover medical expenses when you retire. After 65, all medical expenses are fully tax deductible.
  6. And last but certainly not least, you defer the payment of income tax. You are taxed on your regular RA income in the same way that you are taxed on your regular pre-retirement income. However, your post-retirement income will likely be lower than your pre-retirement income, thus bringing along the possibility of being taxed at a lower marginal tax rate.

Does this sound too good to be true? Asking yourself where’s the catch? Well, one thing to remember is that by investing in an RA, you are “locking in” your investment until normal retirement age. So the soonest you can withdraw anything from the fund will depend on the fund rules, but this is normally age 55. However, this is also not necessarily a bad thing, as you do not have to exert the self-discipline required not to touch any funds earmarked for retirement, which can happen so easily in a discretionary investment when times are tough.

So now that we’ve determined that an RA is a good vehicle to use for funding retirement savings, the focus must shift to which RA to use.

Introducing the new generation RA

There exists a miss-perception that RAs in general provide below par investment returns. This is not necessarily the case, especially if you look at so-called new generation RAs.

The features of a new generation RA include:

  • The flexibility to alter the regular contributions into the plan in line with a change in the client’s financial circumstances (e.g. upon receiving a raise in salary, or being retrenched for a certain period);
  • The flexibility to inject extra lump sums over and above your monthly contributions or lump sum benefits;
  • The freedom to stop contributions and to preserve the accumulated benefits until retirement age is reached.

These products can be purchased from most asset managers, certain life insurers as well as Linked Investment Service Providers (or LISPs). Whether or not you buy the product directly from an asset manager or from a LISP will have little effect on the product’s structure, but it does significantly affect the underlying investment options available to you.

If you decide to purchase an RA directly from a specific asset manager, you will only have the option to invest in a range of unit trust funds from that asset manager, or a limited range of unit trust funds from a few accredited asset managers.

On the other hand, if you buy an RA through a LISP, you get the following advantages:

  • A large range of investment funds to choose from (for example, through Glacier by Sanlam you can choose from close to 1000 unit trust funds);
  • The flexibility to invest in unit trust funds from more than one asset manager at the same time, and to receive centralised reporting on the performance of these investments;
  • The flexibility to switch between unit trust funds at any time, normally free of charge;
  • The opportunity to invest directly into a share portfolio. This is a major advantage of buying your RA through a LISP, as an asset manager is not normally able to provide this service to you. It is also important to ensure that the LISP through which you buy the product is able to provide you with this functionality. Glacier by Sanlam is an example of a LISP that provides this service.

The growth in the sales of new generation RAs through a LISP has been phenomenal, and we expect that the LISP RA market will surpass the life insurance RA market in the following five years, based on conservative estimations, which is amazing if you factor in the relatively short time that the LISP industry has been around.

Regulation 28

The investments underlying contractual savings products, under which the RA is classified, are governed by regulation 28.

Regulation 28 restricts the maximum exposure that you can have to certain asset classes:

Asset classMaximum exposure
Equity75%
Property25%
Foreign25%

A seamless transition from pre- to post-retirement

Now that you have arrived at retirement age in top financial shape, having worked hard for your money, it’s time to let your money work for you. However, once again, you’re faced with the daunting task of deciding which product will best suit your needs.

In the current financial market, you have a choice between two major product classes: a guaranteed life annuity (GLA) and an investment linked living annuity (ILLA).

A GLA has the following characteristics:

  • Income is guaranteed to be paid for life, i.e. there is no risk of you outliving your retirement savings;
  • The income amount is guaranteed at inception, and can be either level or increasing at a predetermined rate;
  • There is normally no (or very low) payout on death.

An ILLA has the following characteristics:

  • You have full underlying investment freedom
    • As with an RA, you can choose to buy an ILLA directly from an asset manager or from a LISP;
    • The investment options available through a LISP are normally much more than through an asset manager, and may also include investment directly in a share portfolio;
    • There is thus scope for a seamless transition, in terms of investment strategy, from your RA to an ILLA;
    • Regulation 28 is not enforced under an ILLA, but is still promoted as a prudent investment guideline for the investments underlying an ILLA.
  • You can choose an income according to your income needs, as long as the chosen income is not smaller than 2.5% or larger than 17.5% of your retirement capital.
  • You have the freedom to adjust the income taken annually on the policy’s anniversary, as long as the 2.5% - 17.5% annual restrictions are still being adhered to.
  • There is no guarantee that income will be paid for life, so there is thus a risk that you will outlive your retirement income.

As with RAs, there has been tremendous growth in the amount of ILLAs sold within the LISP market, because of their transparent design and the investment and income freedom they provide.

Financial advice

The intention of this article is not to provide financial advice and clients are urged to seek financial advice from an accredited financial intermediary.

Sources:
http://www.10x.co.za/individual/retirement-annuity-fund/faqs/
http://www.oldmutual.co.za/personal/retirement-planning/retirement-funding/pretirement/save-tax-with-an-ra.aspx
http://www.10x.co.za/faqs/retirement-annuity/what-is-pensionable-income/
http://www.iol.co.za/business/personal-finance/columnists/bruce-cameron/retirement-lump-sum-how-much-to-take-1.1417001#.UoSgNPmnrus

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