MAXIMISING YOUR RA TAX SAVINGS

With the tax year drawing to a close, how do I make sure I’m maximising my tax savings in my retirement annuity (RA), and is there anything I should be doing to prepare for the end of the next tax year?

Anonymous

David Chard, the head of life and investment at PSG Wealth, responds: Your RA contributions reduce your taxable income, up to certain limits. As a result, you pay less income tax, up to the specified limit (27.5% of the higher of your taxable income or remuneration, capped at R350 000 per tax year). This effectively means that your contributions are partly subsidised by tax savings. 

Another advantage is that the growth on your investment is tax-free. In addition, at retirement, the lump-sum benefit portion is exempt from tax up to a specified limit. Furthermore, not only is tax delayed until retirement, but, ultimately, you will pay less tax. This is because the tax rebates, tax rates and allowable deductions for people aged 65 and 75 reduce their tax liability.

Your RA savings are safe from creditors and any form of personal financial liability you may suffer during your pre-retirement years. This ensures that you will still have retirement savings available when you retire, even if you suffered some financial setbacks during your working years.

An RA is designed to help you save for retirement and can usually be accessed only once you have reached the age of 55. Some exceptions apply in special circumstances, however – for example, if you become disabled or emigrate.

The Income Tax Act allows members of an RA fund who have not yet retired but who have emigrated to access a lump sum from their RA contracts. This requires permission from the South African Reserve Bank and will be granted only to someone who has formally emigrated. Note that this lump-sum payment will be subject to tax.

How often and how much you must contribute to an RA depends on the specific product you select, but generally contributions can be made in the form of a lump sum, a regular debit order or ad hoc payments. The minimum initial lump-sum investment for the PSG Wealth Retirement Annuity, for example, is R20 000, and the minimum amounts for debit-order investments are R500 a month, R1 500 a quarter, R3 000 half-yearly and R6 000 yearly. You won’t be penalised if you miss, stop or reduce your debit-order investments, but the growth of your retirement savings will be impacted.

RAs are designed to help you save before retirement, to ensure that you have a pool of savings from which to draw an income once you retire. Make the most of the time you have and the tax benefits RAs provide as you get one year closer to retirement. 


LIVING ANNUITY COSTS AND RETURNS

I am 64 and retiring soon, and intend taking out a living annuity using most of my retirement savings. I have yet to decide on the provider or the make-up of the portfolio. Can you outline all the costs I will be paying on such a product – once-off and annual costs (both fixed and as a percentage of assets)? I am looking at an initial annual withdrawal of 4%. What sort of return will I need to offset the costs and keep pace with inflation?

Name withheld

Marius Cornelissen, a financial adviser at PSG Wealth in Menlyn, Pretoria, responds: The costs of investing in a living annuity can vary significantly. The investment platform, the underlying funds used in the living annuity and whether or not you use the services of a financial adviser can determine the total fees charged. Some of the most relevant fees are:

• Initial advice fee, which is charged by a financial adviser and could be a fixed fee for the financial plan, or a percentage-based fee up to 2% of the value of the investment.

• Initial investment platform fee, which is charged by the living annuity platform provider. It can be a percentage-based fee, although most providers do not charge this fee anymore.

• Switch fee, which is usually a small fixed fee charged when underlying funds are changed. It varies among providers, because some do not charge for switches, whereas others may allow a certain amount of free switches per year.

• Ongoing provider platform or administration fee: This varies among providers and is usually a percentage-based fee on the value of the investment. Some providers charge no administration fees for investments allocated to their own in-house funds, while charging the fee on investments made in funds from third-party fund managers.

• Total investment charge (TIC) of the underlying funds used in the living annuity: This is the percentage-based annual fee charged by the fund managers of the underlying funds, as well as the associated transaction costs. Fund returns are always quoted after deduction of the TIC. 

• Financial adviser fee: If you use a financial adviser, he or she will usually charge you an ongoing percentage-based fee that can be up to 1.2% a year, depending on the size of the portfolio.

• Other fees: Some providers charge extra fees, such as an annuity payment fee that can be a small monthly or an annual fixed fee.

Your annual drawdown rate – the percentage of your investment value that you draw as income – plays a big part in how long your money will last. The other two factors are fees and inflation. If you have a drawdown rate of 4%, and inflation averages 5% over time and your fees for product administration and financial advice are 1%, you will require a 10% return on your underlying funds (as reported net of their TIC).


WHY ARE RETIREES SO BADLY OFF?

With retirees aiming to have a big capital base invested so that the performance of their portfolio is higher than the rate of inflation and spending requirements, why do so few South African retirees find themselves in this position? Why is it so difficult to save enough?

Name withheld

Jac de Wet, the national head of sales at PSG Wealth, responds: The actions and decisions that investors make before and after retirement contribute to the reality of far too many ill-equipped retirees in South Africa. Investors are meant to build up a “big capital base” in the pre-retirement phase, but many simply fail to accumulate enough. Post-retirement, some investors also fail to grow their capital base sufficiently, while others have drawdown rates that are too high. 

The three common reasons for not accumulating enough before retirement are: 

• Allocating too little to growth assets. Growth assets, such as equities and listed property, outperform more conservative assets, such as cash and bonds, over the long term. Growth assets are needed in any investment portfolio with a longer time horizon, but these assets typically come with higher levels of short-term volatility. It is not always necessary to move assets from growth to conservative assets as investors approach retirement, because the investment term after retirement is usually longer than expected. These risks, uncertainties and emotions should be managed to keep investors on track. 

• Not saving early enough. Longer life expectancies mean investors need to start saving as early as possible and keep saving for as long as possible. Compound interest is touted as the eighth wonder of the world, but it takes time to work in your favour, so it is best to start saving as early as possible. Medical advances mean that lifespans are increasing, and investors often don’t realise how long their retirement could last. 

• Failing to consider how much is needed and cashing in what has already been saved. Generally, people don’t save enough, but they also don’t consider that longer lifespans mean they need to have accumulated even more capital by the time they retire. This could also mean higher medical expenses, which need to be factored in to budgeting. Failure to plan and a lack of commitment to savings plans are factors, as is the tendency not to preserve retirement funds when changing employers. 

People often make the following mistakes after retirement:

• Drawing too much income at a higher rate than the investment is earning, which results in investors eroding their capital. If this continues for too long, they run the risk of depleting their capital. 

• Poor management of expenses. Retirees can often not continue with the same lifestyle post-retirement. It is essential to make adjustments. Obtaining advice from a professional with the Certified Financial Planner designation and following sound investment strategies can help in managing post-retirement income and ensuring that it will last the distance. 

• Not growing a portfolio after retirement. In the face of investment risk and longevity, a portfolio consistently has to perform in excess of 10%. This implies some exposure to growth assets, or taking a low income drawdown. Either way, a growth rate of more than 10% is difficult to achieve in the current environment, and investors can benefit from the guidance of a qualified adviser.  

Email your queries to [email protected] or fax them to 021 488 4119. This feature is sponsored by PSG Wealth.