Expert Advice: Why you should have a retirement annuity

With the financial status of our country and many people struggling to make ends meet, saving for the future might be the last thing on your mind. 

Although many South Africans take out insurance policies such as life and funeral cover policies, many aren't saving enough for their retirement. 

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A Sanlam Benchmark Survey revealed that South Africans are starting to save for retirement five years too late. Not only that, but they are also saving too little (7% vs the suggested minimum of 15%). 

The survey revealed that the majority of retirees are struggling to make ends meet and that a third of retirees can’t cover their medical expenses.

We caught up with Financial Advisor Allan Shine to talk about the importance of having a retirement annuity and some of the common mistakes people make when taking one out. 

How important is a retirement annuity? 

Retirement annuities are a tax efficient way of saving for one's retirement as part of a professionally-structured financial plan. They allow you to contribute to an investment, usually receive your marginal rate of tax back on your contributions, and have tax-free growth within the investment. This allows for one very good vehicle to achieve the capital amount needed in the shortest time to replace your employment income. So it is an important tool in anyone's retirement savings and tax strategy, whether you are wealthy or just starting out. This should be done as part of a larger strategy which should also factor in liquidity needs.

Is there a difference between a retirement annuity and provident fund? 

There are differences, but they are similar in that they are both retirement savings vehicles that can both be used as part of your retirement savings plan. 

They are different in that the Pensions Fund Act does not provide with any withdrawals prior to retirement on a retirement annuity (except on death), but currently, you may withdraw your provident fund benefit should your employment end for whatever reason. You are a member of a Provident Fund, but you own your Retirement Annuity, so your ability to contribute to an RA does not depend on your employment. 

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The tax structures around contributions are currently different, but there are changes potentially happening soon to standardise retirement annuities, provident, and pension funds to all be more like retirement annuities in their treatment to tax deductions and availability of capital prior to retirement. So, before your retirement age, currently you could resign and access the full provident or pension fund benefit - less tax, where with a retirement annuity the earliest you can access anything is at age 55, where you can withdraw 1/3 - subject to tax, and must invest the remaining 2/3 into a compulsory annuity which pays an income of between 2.5%-17.5% of your remaining capital per year until it is finished or you die. 

How do you know which cover is best suited for your needs? 

Your total retirement savings contribution shortfall is the place to start, then you need to consider the tax structure to make full use of your tax deductions. You should then also consider fees and available investment portfolios. It would be relatively normal to be making contributions to both a provident fund and RA at the same time, but you need to pay attention to things like fees, tax, and flexibility.  Speak to your financial planner to help you here on the tax aspect, but be wary of advice to increase your RA contribution if your advisor is remunerated by commission, as it may be cheaper to increase your Provident/Pension Fund contribution rather than increase your RA since there are often no fees on employee contributions, depending how your employer has structured your Pension/Provident Fund. 

What should people be aware of before taking out a retirement annuity? 

Too many people I come across are not aware that they cannot withdraw the full capital amount in cash at retirement age and are in fact limited to 1/3 as a cash withdrawal. They should be aware of the fact that it is a product regulated by the Pension Funds Act, which currently has some rules and regulations which you may find both useful and also negative at the same time. Some retirement annuities have very high administration fees or penalties if you stop contributions, so you should always pay attention to the details and ask questions while doing your own research if you are not speaking to an independent financial advisor who is doing the comparisons for you. 

The current Pension Funds Act and Income Tax Act gives us good reason to use tax-efficient ways to save for retirement, but once your money is in, the laws could very well change and leave you stuck in a product that is not so beneficial anymore and perhaps even something you would not have invested into - it's a risk you take so that you can get the tax benefit now and while it is growing. Examples of potentially negative legislation are Regulation 28, where despite all other examples that Equities provide the highest long-term returns and it is prudent to have a significant offshore exposure in one's portfolio. Reg 28 limits exposure to local and offshore equities and property, basically forcing you into a portion of cash and/or bonds - which may be more stable, but is theoretically dumb for most people who are trying to get the highest growth when starting out at a younger age - I'd go so far as to say it is a way for government to force a portion of your Retirement savings into government bonds despite the fact that you may not want them. What's next? That's also why you should contribute to an RA or Provident Fund as part of a larger investment plan managed by a professional advisor for you. 

What are some of the common mistakes people make when it comes to taking out a retirement annuity? 

Quite often, people take out a retirement annuity and leave nothing to save and invest for shorter-term needs and unknowns. People also get attracted to fancy products linked to life insurance policies, which have great benefits some of the time, but are often not fully understood and end up being very expensive if not properly managed. My general preference is to keep insurance policies separate from investments and not to get wrapped up in the sales talk and fancy brochures promising low fees. Simple is better.  

Are there any other benefits of a retirement annuity apart from getting money when you retire? 

Creditors cannot attach your retirement savings inside a Retirement Annuity. This means that your retirement savings will not be wiped out should you make some bad decisions or get sequestrated.

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Disclaimer: This does not constitute as financial advice or a recommendation. Always speak to a financial advisor when making decisions or changes to your financial planning or products. TSC Financial Services is an Authorised Financial Services Provider #44647.