If you’re thinking of investing in a retirement annuity (RA), consider the advantages according to Rowan Burger, head of investment strategy at Liberty Retail South Africa.
“To prevent people from relying on the government to provide for them in their old age, there are legal restrictions on withdrawing funds from RAs. But there are also tax advantages to offset the lack of access to funds,” says Burger.
- Preparing for retirement.An RA helps you to build up capital during your working years so that you have enough income to enjoy the same standard of living when you retire.
- Ensuring sufficient savings.The rule of thumb is that if you save 15% of your salary over 35 years, you will receive 75% of your salary as a pension, given reasonable returns. The problem is that your pensionable salary (the amount that your 15% pension contributions are calculated on) is usually about only 70% of your total salary benefits which include, for example, a bonus, car allowance, medical aid and other benefits. This means that you could retire on 75% of 70% of your salary. It’s important to save for these “extras” as they do help us meet our current living expenses. For example, if your monthly package is R20 000, you would need to retire on the equivalent of R15 000 (75%). But your pensionable salary is significantly less at R10 500 (75% x R20 000 x 70%). By investing 15% of your non-pensionable income into a retirement annuity, you can make up the savings gap. A starting point is to always invest 15% of your bonus tax-free into an RA.
- Tax benefits.You can invest up to 15% of your total income — less any amount that may be used for other pension fund contributions) tax-free. Not only can you invest with before-tax money, but you do not have to pay capital gains tax or income tax on your retirement investment. Your investment growth will be higher over the long-term as the growth remains in the policy and will usually offer you a better after-tax return than other types of saving. When you retire, you can take one-third of your investment as a lump sum. Of this the first R300 000 is tax-free with a favourable tax-rate for higher amounts. The remaining two-thirds of the retirement annuity is invested in an annuity to provide you with income during your retirement.
- The power of compound growth.Because you are saving over a long period, your money starts to work for you as you earn interest on the interest. If you save consistently over 30 years, less than 35 cents of each rand of income you receive will come from the contribution you paid in. The balance will come from the growth earned on your contributions and savings in retirement.
- Disciplined savings.You do not have access to your retirement annuity savings until the age of 55. This may sound like a disadvantage but it removes the temptation to dip into or deplete your savings while you are working. Here’s an example: Twenty-five-year-old Sipho needs about 15% of his salary through his working lifetime to secure an adequate pension. If he cashed in his savings at 35, he would need to save 25% to get to the same benefit. Starting from a zero base at 45 requires an incredible 47%. The only remedy here would be to retire later.
- Long-term growth.As markets fluctuate during different economic cycles, your consistent contributions will average out this variability. You also draw your pension over a (hopefully) prolonged period. Therefore, what happens in a turbulent investment market is of less concern to you. The average investment manager has delivered returns which are 11% above inflation over the past five years, despite the recent global economic crisis.
- Supporting your dependents.If your dependents are left to cope without you, your retirement annuity can provide a source of income for those you leave behind, especially if you buy death cover on your policy. The cash benefit from a retirement annuity falls outside your estate, so if you die and are insolvent, your benefit is paid to your family rather than your creditors.
- Room to grow your savings.While pension funds generally require a contribution that is a fixed percentage of your salary, RAs offer more flexibility. Many people recognise the need to save but struggle in the short term to meet financial obligations. A retirement annuity allows you to slowly increase your contributions over time. For example, you could take 3% from each of your next five years’ salary increases to get to the full 15% contribution. You can also invest a portion of your bonus each year as a lump sum contribution.
- Diversified portfolio.You have access to different asset classes in a retirement annuity. You can invest 20% of your savings offshore without needing Reserve Bank clearance. You can also invest in other types of portfolios through your RA, such as direct property, private equity and fund of funds.
- Freedom of choice.With many retirement annuities, you can choose your underlying investment, giving you some flexibility in how your contributions are invested and therefore, how they grow.
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