How an RA can help to gild your golden years
The reason they are so popular is that they offer attractive tax benefits
May 29, 2011 3:08 AM | By Brendan Peacock
What is a retirement annuity? What does it do, how should you use it and how do you get paid out? Most importantly, how do you get one?
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'One of the issues to consider when selecting an RA is the fees charged'
For people who have recently entered the workforce or are beginning to plan for retirement, retirement annuities are something often talked about, but less often understood.
A retirement annuity (RA) is a long-term savings contract that allows you to accumulate savings. The reason they are so popular is that they offer attractive tax benefits, because the government is understandably keen to encourage South Africans to save for their later years.
"RAs are designed to collect savings over and above your traditional employer-based fund and to provide a vehicle for self-employed individuals. Currently up to 15% of your income not allocated to another retirement fund can be contributed to an RA on a tax-free basis. Interest and capital gains earned in the fund are tax-free. On retirement, there are further tax advantages, but since the intended purpose is for your retirement, you are restricted in your ability to access your cash," said Rowan Burger, head of investment strategy at Liberty.
"Even if you change employers, you continue to save into the same RA under your name. When you set up a RA, you contract to invest either a lump sum or regular monthly payments (or a combination of the two). With regular monthly payments, the minimum contract period is five years, and your investment growth is determined by the underlying investments and its fee structure - there are hundreds of RA products to choose from, all with different investment strategies," said Paul Barnard, a financial education consultant at North Star Solutions.
"One of the key issues to consider when selecting an RA is the underlying fees charged. These will be the ongoing administration fees, asset management fees, potential asset manager performance fees and commissions due to brokers. Costs are an important consideration, as these erode the investment return you can earn on your savings," said Burger.
"Your RA fund will allow you to retire at any time from age 55, unless you become disabled or need to retire early due to ill health. At retirement, you will be allowed to take up to a maximum of one-third of the accumulated benefit as a cash lump sum, a portion of which could be tax-free, depending on the amount. There is a sliding-scale tax table that applies on death and retirement. If you have not already used it, the first R315000 of the lump sum is tax-free. The balance must be used to buy a compulsory annuity to provide you with a post-retirement income, which will be fully taxable at your marginal rate of tax. But you can also use the whole value of your RA fund to buy an annuity. If you retire from more than one RA fund and pension, provident and preservation fund, the tax-free lump sum to which you are entitled applies to the total of all lump sums received," said Peter Dempsey, deputy CEO of the Association for Savings & Investment in South Africa (ASISA).
"If the client's total value in the RA is less than R75000, they may take the full amount in cash, although this lump sum may also be subject to taxation," said Linda Sherlock, head of advisory, retail at Alexander Forbes Financial Services.
How much should we be putting away? "Conventional wisdom is that individuals need to invest at least 15% of their pre-tax income for at least 35 years in order to buy a pension that will enable them to maintain their lifestyle when they retire. This 15% investment is often a combination of your employer's contribution and your own contribution. If you did not start saving 15% of your income at least 35 years before your retirement age, an RA may be the investment vehicle you need to make up the shortfall. If you have discretionary savings that make up the shortfall, this may assist you in reaching your retirement savings target," said Barnard.
"An RA is actually a fund which you join as a member. There are basically two types of RA funds available to investors: the life-linked RA fund and the unit trust-linked RA fund. The fund buys either an insurance policy from a life insurer or it invests in unit trust funds on your behalf. Your fund contributions are paid to the insurer as premiums under the policy or as monthly contributions to the unit trust company. The fund provides you with a certificate of membership, which usually includes a copy of the policy documents," said Dempsey.
A life-linked RA fund normally commits you to a certain term and premium. "If you stop paying the premiums, reduce them or change the policy term as a result of early retirement, the policy value will be recalculated and can result in a reduction of the policy values and hence the benefits paid, although penalties are less severe than they used to be. While you cannot retire from an RA fund before age 55 unless you become disabled, your premium-paying term can end much earlier or be paid in a lump-sum premium."
At tax-filing time, the RA provider will issue a tax certificate to you.
"An RA can be set up through any number of authorised financial service providers such as banks, insurance companies, asset management companies or through your financial adviser."
What you absolutely must know
You cannot make withdrawals from your RA fund prior to retirement unless you formally emigrate or the value falls below a certain minimum amount;
RA funds are protected against most creditors, with the exceptions of a spouse or child entitled to maintenance in terms of a court order, and the Receiver of Revenue. This is especially important if you are self-employed;
New-generation RA funds allow their members to choose from a diverse range of underlying investments - funds which concentrate on a certain asset class. Members are also allowed to switch their money between funds if this becomes necessary because their needs have changed;
You may contribute to your RA fund via a one-off lump sum (single premium), regular premiums or ad hoc lump sum instalments;
RA funds accept transfers from approved pension, provident and retirement annuity funds. They also accept voluntary contributions;
If you haven't contributed the full tax-deductible amount for the tax year, you can make a lump-sum payment to the RA at the end of the year;
If you have paid more than you should have done in taxes, you will be able to deduct that money in future tax years;
The law allows you to move from one RA fund to another. However, this process usually takes several months to complete;
You can extend your retirement date annually, which allows your capital to grow until you need it. Note that many RA funds these days do not have a fixed contractual retirement date - instead, they are open-ended. Even if they do have a contractual fixed retirement date you can always apply to extend the contract if you do not want to retire on the date originally laid down; and
At retirement you have to use at least two-thirds of your pension money to buy a compulsory annuity, which will be paid out to you in monthly instalments. There are many different types of annuity on the market, and it is important to get good advice. This will ensure that you buy the right type of annuity to cater for your personal circumstances.
