In our previous article we discussed the different types of ‘ways’ you might invest towards your retirement. We say ‘ways’ in that each manner described, was really just a wrapper or framework for investing your money. What ultimately dictates your returns are the asset classes contained within each investment – not the wrapper itself.
A unit trust cannot give you a rental return, but the listed property shares inside might just.
There’s a wrapper for that
Some wrappers do however offer tax benefits and are designed in a way to make it easier for you to automate your retirement savings. One such wrapper is the Retirement Annuity (RA).
These are the go-to retirement products that are most often recommended to you by an advisor or a broker.
An RA is a way of saving for the future, but in a tax-deferred way. What this means is that you get to put your hard-earned money into your RA, have it grow over the years, and not pay any tax on the investment returns while it’s still inside the RA.
Why this deferral works so nicely in your favour, is that it allows you to contribute to your RA savings for decades, without having your investment value reduced a little bit every year by tax. Ordinarily, if your retirement assets earned interest, rental, and some capital gains – these would all attract tax.
With an RA, these amounts are still earned, however you don’t pay any tax on them. Simplistically put, this means that your investment balance at the end of every year is bigger than it would have been. Bigger amounts mean more exponential compounding.
In addition, you’ll get an income tax deduction for your contributions to your RA. The caveat is that when you want to take money out, you need to pay tax on it.
This goes back to our discussion on income tax in general in SA, where we explained that if you get a deduction from your annual tax charge now, expect to pay tax on the proceeds in the future.
One question that often gets asked is: “what is the one thing I can do to accelerate my retirement savings having left things a little late?” In most cases, some good advice would be to consider a tax-deferred savings vehicle like an RA. The extra compounding achieved by postponing your tax liability is invaluable in boosting your retirement balance. We’ll touch on this down the line.
SARS is on your side
This tax benefit isn’t some giant South African Revenue Service oversight; these retirement products are designed like this to incentivize people to invest and to allow them to grow their retirement assets more meaningfully over the long run. Believe it or not, our government wants its citizens to be financially secure in retirement and not to ultimately be a burden on the State later in life.
Your RA is your Best Friend Forever, and it can go everywhere with you
The great thing about an RA, is that it’s entirely portable. An RA is taken out in your name, not your employer’s. It is also in no way linked to your job. You could change jobs, go on a sabbatical, or even change careers and your RA would be unaffected.
Some life insurance companies will even allow you to push ‘pause’ on your contributions, and pick things up again when you feel ready to.
What happens when you retire?
Upon retirement there are a few things you will have to do with your RA. You can take up to a third as a lumpsum and will pay tax on this amount, but the rest needs to be used to buy an income stream.
This income stream will be an annuity, of which there are two kinds. A Life annuity is where a life insurance company guarantees to pay you an amount for life; you never have to worry about what the stock market does – all you focus on is getting your monthly annuity income.
The other is a Living Annuity. This keeps the risk that your retirement money might run out, entirely with you. In a Living Annuity, all your RA money is typically used to buy a host of different unit trusts. Over time, you elect how much to draw down from your RA on the anniversary date of your RA, allowing you to reduce your income or increase your income as your needs change.
In most instances a financial advisor will advise upon and help you decide as to what unit trusts are best for you in your retirement, and as you’ll appreciate, if the value of your unit trusts goes down, so your retirement balances will go down.
It’s like a puppy
An RA is for life. That’s the downside at least.
If you open an RA and contribute money into it, don’t do so unless you’re prepared to wait until you are at least 55 to get it out. This is an intended rule to prevent people from pillaging from their own retirement when they aren’t retired.
So where does all this ‘low cost’ stuff fit in?
A few article ago, we talked about the rot that is ‘compounded costs that add no value’. Here is how you apply this when you consider your RA.
- Some RA providers charge more per year for their admin fees. See if you can shop around and find a provider who will charge you less.
- In this regard, please remember that if you pay less, it does not mean that you get less. Paying more for an RA does not have one inkling of relevance in terms of your investment performance. An RA is an admin wrapper – that is it. Find a cheap one and you’re winning at personal finance.
- When you engage with a financial advisor, they are likely to charge you an annual fee for looking after your RA and for monitoring your unit trusts within your RA. Enquire on these fees and negotiate if need be.
- When you do ultimately choose what unit trusts to go into your RA, either while still saving toward retirement or once retired, these will all carry fees. The annual RA admin fee might be low, but a life insurance company might restrict what unit trusts you can invest into, which in turn might all be very expensive.
- Consider an RA that allows you to invest in passive investment funds as opposed to actively managed investment funds.
Get paid or die trying
Not unique to an RA, but the great thing about contributing to an RA, is that you can contribute via a debit order. Automating your savings into a vehicle where you cannot get access to your money is a great way of ensuring that you stay committed to your investing goals, and don’t sabotage yourself by plundering your wealth.
As usual, the choice is yours
Investing into an RA is not mandatory. Ultimately, someone like a financial advisor will help you make sense of your current financial position and your investing goals, and advise you accordingly. It may be that you have an adequate employer pension fund, or savings outside of a formal retirement vehicle.
Some people choose to shun the formalised retirement industry altogether. They are fine with not getting any deductions for contributions to a retirement vehicle, as they feel happier not paying income tax on withdrawals from their investment down the line.
If you realise that you need to do something about your retirement sooner rather than later, consider how an RA might help you meet your investing goals by reaching out to a financial advisor.