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By Maria Smit*
Young investors need think carefully about investing in a RA
Saving for retirement – from the day an income is earned – is one aspect of an overall financial plan that is strongly advised by most advisors, especially as report after report highlight SA’s poor savings culture and underfunded retirement capital.
The smart investors who include a retirement plan in an overall financial plan, typically select a Retirement Annuity as the vehicle of choice. But is this suitable for younger investors? What are the issues to consider? Brenthurst Wealth Financial Planner, Maria Smit, elaborates.
With all the talk about prescribed assets and the low growth forecast for South Africa one must ask the question does the tax saving you receive justify saving in a retirement annuity vehicle.
You do not have any access to it. No matter how big your emergency is:
Many South Africans were faced with a financial dilemma when COVID-19 lockdowns hit. Using savings during times of financial strain are advisable, as opposed to getting into debt to cover living expenses when regular income is lower than before – or in some instances almost down to zero. Those who committed all savings to a retirement annuity will have no option but the debt route as funds in RA’s cannot be accessed before age 55.
If you are thinking of emigrating:
Emigration among younger adults has been on the rise. So, if you are thinking of emigrating to another country, it is not wise to save in a retirement annuity now because you can only access the funds at retirement. And that might mean you reach retirement age in another country. Would it then make sense to receive income from a rand-based retirement annuity? It is also not easy to access the funds when you emigrate.
When officially emigrating, you may withdraw the full capital amount, but it will be taxed. To take your Retirement Annuity savings abroad, you need to emigrate formally, and you need to do so before you reach your fund’s specified retirement age. Formal emigration requires you to sign off with SARS, which triggers capital gains tax on all your capital assets (other than on your fixed property located in South Africa). Once all your tax affairs are in order, you will receive a tax clearance certificate that will entitle you to withdraw from your RA. The proceeds will be taxed according to the withdrawal lump sum tax table. If you are invested in a life company RA, you may also incur ‘termination penalties’ for withdrawing early (depending on the contracted investment term and fund rules).
Growth of a retirement annuity is limited:
Investors cannot select the asset allocation.
The basic underlying limits imposed under Regulation 28 the Pension Funds Act:
- 75% in equities,
- 25% in property either local or international,
- 30% in foreign investments excluding Africa, and
- 10% in Africa, not counting South Africa.
If you are a young South African with a time horizon of 10 -15 years before retirement it makes sense to take on more risk in the form of equities. So, in the long term a fund with just 75% equity exposure, your portfolio will underperform compared to a 100% equity fund. You are also forced to not invest more than 30% in offshore equities. So, you can only diversify 30% of your portfolio to shares outside of South Africa. The rest of your portfolio is stuck in less than 1% of the world economy.
Average return of the top South African Balanced fund that is Regulation 28 compliant:
Source Allan Gray Fund Research tool
Let us work with 6% annualised performance over the past 5 years.
Average performance of the top offshore feeder funds:
Source Allan Gray Fund Research tool
Let us work with 11% annualised performance over the past 5 years.
What about the tax at Retirement?
It is advisable to save 15% towards your retirement.
While RA’s give you a very nice upfront tax benefit, you give some of that tax back later:
For South Africans in higher tax brackets there is no arguing the annual tax saving they receive. But with the governing party proposing changing regulation 28 of the Pension Funds Act to boost the funding of infrastructure projects spearheaded by state development finance institutions (DFIs) using private capital, after the billions of taxpayer money already mismanaged to developing SOE’s it makes one want to take control of your finances into your own hands. And with the accessibility of quality offshore funds why would you give up better returns in the long term for short term savings. There are also ways of saving on Tax in discretionary investments. Like investing in a Tax-Free saving account. Where you can also invest 100% in offshore feeder funds.
The personal circumstances of every individual investor are unique and a strategy suitable for one may be completely inappropriate for another. To navigate the vast universe of investment options it is advisable to consult with a qualified, experienced financial advisor. Read more about retirement planning.
- Maria Smit is a Financial Planner at Brenthurst Wealth.