What is a retirement annuity?

Johan Stadler, regional head of First National Bank (FNB) Financial Advisory, explained that a retirement annuity (RA) is a tax efficient investment vehicle for individuals who wish to enjoy a certain standard of living when they are no longer employed.
 
He said that if you are not a member of a pension or provident fund, then a RA is an ideal investment vehicle.
 
“Investing in a retirement annuity can be made through a lump-sum or monthly contribution. Alternatively, investors can transfer their retirement fund benefits to an RA, subject to fund rules,” said Stadler.  
 
Krisen Rabindra, national sales manager at Standard Bank Financial Consultancy, elaborated: “The main difference between an RA and a company pension plan is that RAs are paid for by individuals who are self-employed or who work for a company that has no retirement scheme. In other words, they are individual, tax-deferred savings plans.”
 
Retirement annuities
 
Stadler pointed out that when changing jobs, a retirement annuity can be used to invest any pension fund benefits that you received when you left the company.
 
However, “Unlike pension and provident funds, members of RAs are only permitted to access their investment subject to the fund rules at a minimum age of 55, and must retire from the fund. No prior withdrawals are permitted unless investors are emigrating or the fund value remains less than R7 000,” explained Stadler.
 
According to Stadler, RAs are suitable for a range of different people. “Individuals who are employed, self-employed or work for companies which do not provide for pension or provident funds can take out an RA.”
 
A living annuity
 
Stadler added that retired people can also make use of an RA, by contributing their pension fund benefits to an annuity.
 
“A portion of the retired individual’s funds can be allocated to an investment product for growth. Some can be transferred to a living annuity in order for the investor to receive monthly income on their investment depending on the client’s needs,” noted Stadler.
 
Rabindra added: “A living annuity is a unit trust portfolio from which you may withdraw five percent to 20 percent annually, but you should withdraw a percentage which is lower than the expected growth of the portfolio, leaving the capital intact. If you pass with a balance in this product, the funds become part of your estate.”
 
Reaching retirement
 
“Once you reach retirement age and you were part of a retirement fund, you are faced with the question of what to do with your retirement savings that you have accumulated over your working career. By preserving your benefit every time you've changed jobs, contributing adequately and selecting an appropriate investment strategy, your retirement savings can be quite significant,” explained Yusuf Nanabhay, head of product development at Momentum Employee Benefits.
 
Once you have reached retirement, you can withdraw a certain percentage of your savings (the amount will depend on the type of fund you have been investing in). The remainder of the money will go into an annuity, which will provide you with an income in your retirement. There are different annuities to choose from.
 
Nanabhay noted: “Many individuals select an inappropriate annuity for their specific circumstances and, as a result, they are left in an uncertain financial position that could have been avoided if they had understood the options available, the pros and cons of each and worked with a licensed financial adviser to make the correct choice.”
 
Three of the annuities that people can choose from are living annuities, conventional annuities, and with-profit annuities.
 
The benefits of a retirement annuity
 
According to Stadler, there are several benefits to taking out an RA. These include:

• Income tax benefit: Contributions to an RA are tax deductible up to a maximum of 15% of non-pensionable income, thus reducing the investors’ tax rate on pensionable income.
• Returns are not taxable: Investors are not taxed on their investment returns earned from an RA until retirement.
• Lump-sum benefits taxed favourably:  Lump-sum benefits are taxed according to a sliding scale and are inclusive of a R500 000 tax free portion on retirement.
• Diversified portfolio:An RA can be structured depending on individual factors such as time horizon, risk profile, retirement objectives and with exposure to different asset classes such as equities, bonds, cash and properties. Regulation also allows for a maximum of 25% toward offshore assets to be included in the structuring of an RA, broadening exposure to other markets for long-term growth.
• Protection from creditors:Your RA is always protected against claims from creditors.
• Exempt from estate duty:Your RA will not form part of your estate.

Beth Orchison, a certified financial planner, agreed, elaborating on the benefit of the deductibility of contributions.
 
Orchison explained: “You can deduct your contributions to your RA from you taxable income, therefore reducing your tax. There are of course limits to the deduction but they are not restrictive for most individuals.
 
“As an example, you earn R30,000 per month (tax rate of 30%) and don’t have other retirement funds with your employer. You contribute R1,000 per month towards your retirement annuity; your deduction will be R12,000 per annum. Without an RA you would pay R108,000 tax, whereas with an RA you would only pay R104,400. That’s a substantial tax saving of R3,600. The government essentially funds 30% of your retirement savings.”
 
Furthermore, Orchison noted that there are also some disadvantages to an RA. These are:
·         You cannot access your funds before the age of 55. (However, this may be a benefit as well as it forces people to save their money.)
·         You are restricted to only taking out one third of the funds in cash at retirement. “The remainder needs to purchase an annuity, which will pay you an income during retirement,” said Orchison.
·         The income that you receive from the annuity will be taxed.
 
When should you take out a retirement annuity?
 
Stadler noted: “All individuals, regardless of their current pension or provident fund contributions need to start saving towards an RA as early as possible in their careers. Investors who are in retirement can also preserve their wealth by investing in a retirement annuity.”
 
Stadler highlighted the importance of contacting a financial adviser to help you make the best choice to meet your needs.
 
“It is important for one to contact a financial advisor who will be able to conduct a thorough financial needs analysis and provide advice according to the individual’s goals while considering the clients current financial position.”