Readers pose questions about whether retirement annuities are worth it; we investigate

“I was wondering if you have any advice on RA’s as a retirement investment. I have heard a lot of commentary about not going through RA’s as they tax you much more on withdrawal,” writes Scott.

 

Andreas raises the question of what happens when a member of a retirement annuity dies, who has discretion over the payment of the funds?  There is also the issue that the returns on the annuity after retirement can often be very low.

 

Phil wonders if it is worth investing in a retirement annuity if they are earning an income abroad. “My wife and I have just turned 30 and we are teaching overseas. We plan on returning to South Africa and we will also be retiring there. Is it worth investing in a retirement annuity as we will not benefit from the tax deduction and will be investing with after-tax money,” writes Phil who is considering investing in Coronation unit trusts instead.

 

Maya replies: (also listen to the podcast)

Research by Liberty showed that over a twenty year period the tax benefit of contributing to a retirement annuity increases the income in retirement by a massive 60%!

 

Liberty made some assumptions including a margin tax rate of 40%, investment growth of 10% a year and an annual increase in premiums of 5%. Based on a starting annual contribution of R20 000, twenty years later the retirement amount would be R1.6 million in the RA compared to R800 000 in a unit trust. The RA lump sum allows you to earn an income 60% higher than that from the unit trust.

 

This research was done before the introduction of dividend tax and the increase in capital gains tax, both of which are not payable in a retirement annuity. Therefore the tax benefits have increased even more since then. Even if your personal tax rate is lower, these figures are compelling.

 

In terms of the tax you pay in retirement, you are able to withdraw one-third at retirement of which R300 000 is tax-free. The rest is taxed based on a set tax table. The two-thirds are invested in an annuity – you can select a fixed annuity which pays you an income for the rest of your life or a living annuity where you invest the two-thirds in a portfolio and draw down on those funds each month.

 

The income you receive from these investments is taxable however people over the age of 65 pay less tax and you will probably need less income in retirement (usually 75% of your working salary). Most people find that the tax benefit during accumulation more than offsets the taxes paid in retirement. Also remember that there is no tax on the interest, capital gains or dividends within the living annuity. If you have a unit trust or share portfolio to provide your retirement income, those taxes will apply.

 

While most people focus on the initial tax break with a retirement annuity, the underlying investment in a retirement annuity does not pay tax on any dividends and interest in the fund and there is also no capital gains tax.

 

Rowan Burger from Liberty has done some calculations on the impact of these taxes and has calculated that over a forty year period your total lump sum would be 12% higher if you did not have to pay dividend or capital gains tax.

 

So the question is whether this gain is offset by the additional costs of an RA versus a unit trust. There has been criticism over the costs of retirement annuities but what many people do not realize is that they can access a retirement annuity through a unit trust platform at a much lower cost with greater flexibility. For example Old Mutual has an index tracking RA that has an annual fee of less than one percent!

 

Phil in his question specifically mentioned Coronation and it makes for a good comparison as Coronation offers both unit trusts and retirement annuities. Coronation charges NO additional fees for the retirement annuity platform; in fact they subsidize the 0.2% fee.

 

The only fee you pay is the annual fee of the underlying unit trust which is around 1.25% in the case of the Coronation Balanced Plus Fund. So in fact your fees would be identical whether you invested in the unit trust or the retirement annuity yet you would receive the tax benefit.

 

However you cannot access a retirement annuity until you reach the age of 55. At that stage you would have to convert two-thirds into an annuity income. You need to decide if you are prepared to lose flexibility in order to have the tax benefit. For many people the discipline of not being able to access the funds is half the reason they invest in an RA.

 

You are also limited to investing in funds which meet Regulation 28 requirements which means that your total exposure to equities is limited to 75%, however that is not necessarily a bad thing given the volatility of the markets.

 

In terms of Andreas point, all retirement funds (including your company pension fund) is managed by a board of trustees. This board has specific fiduciary responsibilities and this includes ensuring that the proceeds of a retirement fund when a member dies is paid to all dependents. For example if a member has children from a first marriage and remarries and has more children –even if the member only stipulates the children from the second marriage as beneficiaries, the children from the first marriage also have a claim.

 

Certainly the costs of annuities, especially living annuities are concern. Again there are lower cost products such as share porfolio’s and unit trusts, but National Treasury has raised this as a priority and over the next few years we should see significant changes in that area including the creation of low cost, lower-risk living annuities.

 

As a final point, a retirement annuity should make up only a portion of your final retirement plan, albeit a larger portion. You should also have discretionary savings which you can access to supplement major expenses and to provide further flexibility. A good way to build up these savings is to invest your tax-rebate (resulting from your retirement annuity contribution) into a unit trust or other discretionary investments.