Cape Town - Retirement Annuities (RAs) are somewhat of a dirty word among many South African retail investors. Sadly they are often seen as ineffective savings vehicles that have provided very little return to a large proportion of investors even after years of contributions.
However, Jeanette Marais, Director of Distribution and Client Services at Allan Gray, says this is largely due to the poor historic cost structures that accompanied old life insurance-based RA policies. RAs were traditionally rolled out by life insurance brokers whose fee structures allowed them to charge a commission upfront for the full life-time of the annuity, which was arbitrarily set at 27 years.
This meant that if you contributed R1 000 per month to an RA and the broker charged a 2.5% commission that was payable upfront, you essentially had a R8 100 liability (R1 000 per month x 12 months x 2.5% commission x 27 year maximum policy term = R8 100) created against your contributions before you’d paid your first rand.
What was worse is that you were also charged interest on the R8 100 commission liability that was created against your RA. On top of this, the Life Assurer also charged you non-transparent upfront fees, which included marketing costs, policy fees etc., which were also added to the liability.
“The old Life-based policies were very poorly structured in terms of cost and one can easily understand why they gave RAs such a bad name,” says Marais. “However, the new generation RAs which are backed by unit trusts are a lot more transparent and don’t charge you upfront commissions.”
Perhaps the biggest advantage of an RA is that they come with significant tax benefits. RA contributions allow for tax deductions up to 15% of any additional income that is not used to calculate your pension or provident fund contributions, such as a bonus, car allowance or commission. If you don’t contribute to a pension or provident fund, you can claim RA contributions equal to up to 15% of your gross salary as a tax deductible benefit. You also don’t pay any income or capital gains tax on your RA investment.
The only catch is that, at retirement, you need to transfer two-thirds of your RA investment into an income-providing product, such as a living annuity or a guaranteed life annuity.These payments are then taxed at a marginal tax rate, which is typically lower at retirement age.
“The beauty of RAs is that because they offer tax benefits the tax man essentially makes a contribution to your retirement savings,” says Marais.
While the tax benefits of an RA speak for themselves, there are certain restrictions that may make an RA unsuitable for you, including investment limits and access to your money. To make sure that your investment is not exposed to excessive risk, retirement fund regulations limit your exposure to higher risk assets, such as equities.
Meanwhile, to make sure retirement savings are kept for their intended purpose, you cannot access your investment until you retire – unless you are permanently disabled or you emigrate.
The earliest permitted retirement age is currently 55. This prevents investors from falling foul of the temptation to withdraw their savings when times are tough. Similarly, RAs cannot be accessed by creditors.
“Not being able to access your investment at times when some cash may be useful, for example if you unexpectedly leave your job, is extremely tough. However, the discipline of having a pot of money which will be there when you finally retire, empowers people to secure a better future,” Marais concludes.
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