Today I’ll tell you what you need to know about RAs. I’ll go through the pros and cons of using this vehicle as a tax savings mechanism.
Once you have the facts, you should be able to decide whether you should contribute a little more before this year’s allowances expire. Next week I’ll have a look at how to maximise your tax savings with a TFSA.
What you need to know about Retirement Annuities
RAs were created as vehicles for individuals to save for retirement. As an incentive, contributions to an RA (within limits) are deemed to be tax exempt. Now, RAs come with a few strings attached. That means while the tax saving might be great, it’s not ideal for everyone.
Firstly, there are limits on how much you can invest within a RA. Secondly, there are strict controls on how and when you can access these savings. And finally, if you are younger than 55, you will most likely have limited options on how you invest these funds.
Now, mostly these limits were designed to save you from yourself. Preventing access and making sure you have a diverse asset allocation should mean you stand a greater chance of having sufficient savings available when you retire.
In SA, RAs are big business, and certain industry practises have emerged over time. One of the most despicable to me are the RA penalties. This can be charged for various “offenses” such as moving your RA to a different company or reducing your monthly contributions. These penalties are not a standard feature of RAs specifically, but rather additional features companies that sell them have added.
Often when I speak to clients about RAs, they immediately shy away from the product because of the negative perception some unscrupulous business practices have created. But I’m here to tell you it’s quite possible to have a RA without these big charges. When you use the right RA in the right way, the benefits can be immense.
So, let’s first look at the real regulatory limitations for RAs:
1. Only contributions below 27.5% of your taxable income, up to R350,000 are eligible for the tax benefit.
2. You cannot withdraw funds before you turn 55, unless you emigrate, or you are going into early retirement due to illness or disability.
3. You cannot invest more than 30% in offshore assets and not more than 75% of your funds can be linked to an equity-based investment.
The Pros: Now given these limitations, what are the key benefits of an RA?
1) You don’t pay taxes on contributions under the limits. Your RA contribution can significantly reduce your tax burden. For example, if your marginal tax rate is 45%, a R100,000 contribution to an RA would translate to a R45 000 tax benefit.
2) Creditors cannot touch your RA savings. If you owe money, your RA is protected.
3) If you lack savings discipline, the limitations on RAs funds will prevent you from making serious errors when unforeseen expenses arrive.
The Cons: So, what are the drawbacks?
1) Your funds are trapped until 55. Not only are you stuck if you face personal challenges and need access to the money, but you’re also going to be stuck if the government changes the pension rules and introduces new requirements.
2) Investment limits, especially the offshore limit, has meant that your returns may be lower than an unrestricted investment. Over the 30 to 40 years that a RA normally runs for, even an underperformance as little as 2% per year could result in a massive difference in your ultimate savings pot. This could easily mitigate the initial tax benefit.
3) You will usually face higher fees on RAs than traditional investment structures. It’s very common for total costs to exceed 3%. I have seen cases where fees have exceeded 6%.
Finally, I’ve also noticed that many clients with existing retirement products are under the impression that their fees are much lower than they really are. All too often a client tells me they’re at 2% on their retirement savings but, once we’ve completed an analysis of the portfolio, the real fees are closer to 4% or 5%. As I said, 2% makes a big difference in the long run.
If you need help to make the most of your tax savings before the 28th of February 2022, send me an email on email@example.com with your number and I’ll do my level best to call you personally.