RA: Costs vs tax benefit

Chris asks: I am retired but currently contracting to my previous employer. I receive a smallish company pension, plus a British government pension. I am debt free and have reasonable levels of liquidity. I am considering putting a lump sum into an existing RA [retirement annuity] (maturing in 2013) and boosting the monthly premium to improve the maturity values. Is this a good idea? Do you recommend any alternative options? I have been reading rather negative press — re the wisdom of RA’s other than as a tax benefit! Your input to this matter will really be appreciated.

Maya replies: Unfortunately, the bad press around RA’s has led to the situation of the baby being thrown out with the bath water. The key is to manage the costs and weigh up the benefits.

Rowan Burger from Liberty sensibly points out that one has to find a balance between the tax benefits of an RA (no tax on interest or capital growth in the retirement annuity and dependant on other retirement savings, further tax benefits at maturity) against both the costs and the fact that there is no flexibility with an RA.

The upside of an RA is the tax benefit. The downside is the cost (although this can be negotiated with your broker and there are new products which are cost effective) and the fact that on maturity two-thirds of the capital has to be invested into an annuity.

Unit trusts and money market funds can be less expensive options and the money can be paid out whenever you require it with no obligation on where you invest it later. However all growth and interest is taxable.

What you need to do is to work out whether the tax benefit is worth the difference in fees between an RA and a unit trust. Your financial advisor or accountant can help you with this. If you do decide on the RA option, make sure you first have a lump sum invested in discretionary investments (unit trusts/money market) that you can access for emergencies because once you have invested in the RA, you will not be able to draw down on it. Also make sure you are using your tax-free interest income allocation to invest in low-risk interest bearing investments. If you are over the age of 65, according to the new budget, you can receive R32 000 of interest income-tax free (that equates to about R540 000 lump sum).