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A retirement annuity (RA) is private pension plan - an investment that is specifically designed to help you save for retirement.
RAs function as a kind of “wrapper” that contains a number of investments in shares, property, bonds and cash.
You can make ad hoc payments whenever you have extra money to invest or regular, set contributions (e.g. monthly, quarterly, etc.).
You can only access your RA when you turn 55; a disadvantage for some and a saving grace for many.
When you turn 55 it pays you a lump sum (of which a large part is tax free and the rest is taxed at a very favourable rate) with a portion of the total value of your RA while the rest buys you a monthly income.
There isn’t a better investment in the universe if your goal is to save for retirement. Here’s why…
1. It’s a free lunch!
There’s no such thing as a free lunch, except when you’re investing in a retirement annuity. It’s no exaggeration to say that government “pays” you a considerable amount of money to incentivise you to save for your own retirement.
How do they “pay” you? Firstly, you can deduct contributions (up to 15 percent of your gross income) to your RA from your taxable earnings.
An example to clarify:
Tuli earns R240 000 per year and contributed R36 000 (15 percent of R240 000) to her RA in that year. She will get taxed as if she earned R204 000 per year.
Tuli would have had to pay R37 360 in tax (based on the 2012/2013 tax tables) if she didn’t pay into her RA. However, she is only liable to pay R28 360 and will receive a nice, fat rebate of R9000. In other words, the government is paying her R9000 to invest R36 000 towards her own retirement.
Put another way; Tuli’s R36 000 investment “cost” her only R27 000 (R36 000 – R9000). That’s a free lunch worth R9000!
Another example to drive home the point:
Candice earns R700 000 per year (putting her in the 40% tax bracket). She contributes R105 000 to her RA (15 percent of R700 000) which leaves her with a taxable income of R595 000.
If Candice didn’t make an RA contribution she would have had to pay tax of R197 685. However, she is only liable to pay R156 557 and will receive a nice, fat rebate of R41 128. In other words, government is paying her R41 128 to invest R105 000 towards her own retirement.
Put another way; Candice’s R105 000 investment “cost” her only R63 872 (R105 000 – R41 128).
This is money for jam! You get a massive, immediate return before netting a single rand in the actual fund.
2. Treasury may soon supersize your free lunch
The already amazing tax benefits of investing in a retirement annuity may soon get even better.
Details are still scketchy, but Treasury is considering whether or not to increase the 15% deduction to 27.5%.
Instead of 15% percent, plug 27.5% into the examples above. Any other investment would have to achieve incredible returns just to break even with a retirement annuity.
3. The ample tax benefits do not end there
The enormous tax benefits of investing through an RA do not stop at the tax deductibility of contributions.
With any other investment you have to pay capital gains tax; not so with your RA.
Paying tax on the proceeds of your RA is deferred until retirement which means there’s a larger balance that’ll compound, tax free, for as long as you remain invested.
If you die the benefits will be paid out to your appointed beneficiaries without attracting estate duty or executors’ fees.
You are only allowed a tax deduction of 15 percent of your gross salary. However, you may carry over any contribution over and above that to next year’s assessment. Whatever is not carried over can be offset when you retire by increasing the tax-free portion of the lump sum you receive.
You will, upon retirement, receive a third of the value of your retirement annuity as a lump sum (with the rest you’re obliged to “buy” yourself a monthly income). The first R500 000 is entirely tax free. The amount between R500 001 and R700 000 attracts only 18 percent tax while the amount between R700 001 and R1.05-million invites tax at a rate of 27 percent. The portion of your lump sum above R1.05-million gets taxed at 36 percent.
4. You get to utilise the most powerful force in the universe to make you rich
According to legend, Albert Einstein called compound interest “The most powerful force in the universe”. Whether or not he said it is up for debate; the veracity of the truism isn’t.
A retirement annuity forces you to save over very long periods which enables your money to start working for you as you start earning returns on your returns. Consistently save for 30 years and you’ll derive less than 35 percent of the income from contributions you made.
Here’s an example to clarify:
Nkosazana, wiser than most at the age of 19, decides to invest R2000 each year for eight years. She achieves a return of 12 percent.
She stops investing at 26 years of age and, therefore, invested a total of R16 000.
Anneke waits until she is 27 years old before she wakes up and starts investing. She puts in the same amount – R2000 – into her investment every year until the ripe age of 65. She also achieves a return of 12 percent.
Anneke kept up her investments for 23 years more than Nkosazana and deposited a total of R78 000 over 39 years.
Who is better off; Anneke, who invested R78 000 in 39 years, or Nkosazana, who invested a mere R16 000 in eight years?
You probably said Anneke, because we’ve evolved to think linearly. Compounding, however, works exponentially with a wealth creating effect that confounds intuition.
By the time they are 65 Nkosazana will have R2.288-million - R700 000 more than Anneke’s R1.532-million! Nkosazana invested far less, but started eight years earlier. Time and compound interest made Nkosazana rich.
5. It saves yourself from yourself
I have no discipline. Good intentions, sure, I’ve got more than a lifetime’s worth. It’s self-control I lack. But I’m not worried; my retirement annuity saves me from myself.
You cannot access your retirement annuity before you are 55 years old. If this sounds like a disadvantage consider that the main reason why those who save for retirement fail to sustain their living standard when they kick back is because they cashed in their pension fund when they changed jobs.
According to Sanlam, about 80 percent of fund members cashed in their pension funds at least once when changing jobs.
Cashing in your retirement savings has the exact same effect as starting late: you’re not only losing your savings but also all the returns you would’ve earned on those savings over the course of your working life.
Make no mistake; eliminating the shortfall of cashing in is, for most people, impossible.
Preserve your retirement savings, tax-free, in a retirement annuity when changing jobs. It’s insane not to.
An example to drive home the point:
Desmond (25) needs to save roughly 15 percent of his salary each month to secure a comfortable retirement. He changes jobs at 35 and decides to cash in his pension fund to pay off his debts and to put down a deposit on a flat in Cape Town’s trendy CBD. He now needs to save about 25% of his salary to secure the same retirement he would’ve had had he not cashed in. He changes jobs again at 45 and makes the same terrible mistake as before. He now needs to save a whopping 47 percent.
Failure is almost inevitable.
6. It takes care of your loved ones when you’re gone
Your retirement annuity falls outside of your estate and is paid to your appointed beneficiary (e.g. your wife) when you die; creditors don’t get a cent and there is no estate duty or executors’ fees.
7. It puts your eggs in many baskets
You can think about a retirement annuity as a box containing a wide variety of investments.
It conveniently feels like a single investment but, in fact, you’re invested in all the main asset classes (local and offshore shares, property, bonds and cash) and an assortment of companies in a variety of industries.
If the company that administers your retirement annuity (e.g. Liberty Life, Old Mutual, PSG, etc.) goes belly up it won’t affect you at all. You’re not investing in the fund manager – it merely manages it – your investment is in all the different companies and other asset classes held within the retirement annuity that simply acts as a shell.
A retirement annuity is a great way to diversify across countries as it allows you to invest up to 20 percent of your savings offshore without clearance from the South African Reserve Bank.
8. It’s safe from creditors forevermore
Your creditors can’t ever, no matter what, touch your retirement annuity if you become insolvent. This is especially beneficial to small business owners.
9. There are many trusted asset managers with a proven track record
Investing through a retirement annuity is a no-brainer, but choosing between the vast arrays of RAs can be bewildering. I suggest contacting any of the well-known and trusted asset managers to start your journey to a retirement beyond your wildest dreams.
Some examples include:
10. Costs are plummeting
Also have a look at these new entrants to the market:
They're probably not yet as well-known as the five asset managers mentioned above, but they offer products with extremely low costs. In fact, they offer the most cost effective retirement annuities by far.
They accomplish this because their products are index trackers. In other words, they do not spend money on actively managing the funds but track the market or a specific index passively, much in the same way as the well-known index tracker SATRIX.
The savings are significant.
In fact, according to Sygnia Asset Management CEO Magda Wierzycka, a lump-sum investor in a passive fund would save 10 percent of her capital over five years in fees.
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