Research shows that whereas our parents worked in the same company for life (retiring with 30 years of pension) our generation is likely to have as many as six career changes. Not only does this often affect pension contributions, but more significantly, at the transition between careers too many South Africans withdraw their pension fund benefits and spend the funds on housing, debt and even holidays.

In South Africa, there are essentially three pre-retirement vehicles available: pension and provident funds for employees, and retirement annuities for the self-employed and employees with non-retirement-funding income such as commission.

Apart from the obvious benefits such as tax incentives, retirement funds also have many associated legislative benefits which specify how and by whom the funds may be used. Chances are that if you work for a company, you will belong to a pension or provident fund. If this is the case then unless you are a commission earner there are very few tax benefits to be gained from using a retirement annuity. You should rather consider other investment vehicles such as unit trusts and exchange-traded funds. If you are self-employed, don?t belong to a retirement fund or earn commission then read on!

What are Retirement Annuities (RA?s)?

  • An RA is essentially a personal pension plan (and is defined by the Pensions Fund Act).
  • There are certain tax concessions available that define the maximum tax-efficient contribution levels.
  • There are also certain restrictions on the withdrawal of the funds.
  • The manner in which the funds are invested is subject to section 28 of the Prudential Investment Guidelines (PIGS). This section defines the allocation of the funds. According to the guidelines, a maximum of 75 percent of the funds may be invested in equities (shares) with the balance of the funds being invested in cash, bonds and property.
  • Any funds in an RA are protected from creditors (as specified by the Pension Funds Act).

    What tax concessions are available for RA's?
    The tax-deductible portion (in any year) is limited to the greater of:

  • R1750, or
  • R3500 minus current pension contributions, or
  • 15 percent of non-retirement funding income.

    Who should consider an RA?

  • Anyone who is self-employed.
  • Anyone who has ?non-retirement-funding? income such as commission or bonuses.
  • Anyone who is not a member of a pension or provident fund.
  • Anyone who is a member of a provident fund ? you can contribute R3500 per annum (about R300 per month).

    Unit trust-linked RA?s can?t be beaten
    Not all RA?s are created equal, however. From a costs, transparency and flexibility point of view, it is my opinion that a unit trust-linked RA cannot be beaten. While an RA with a life insurance company represents a contract between you and the company and any changes to it result in (often heavy) penalties to you the investor, this is not the case with a unit trust RA.

    In a unit trust RA, the underlying investment options are unit trust funds. It has all the tax benefits of a traditional life RA, and has the flexibility of unit trusts. This means you can change the premium at any stage without any penalties to you.

    They operate in exactly the same way as ?normal? unit trusts, but you will only be able to access the funds at age 55 at the earliest. You will then have to use part of the funds to buy a monthly pension for yourself, as is the case with any other RA. The underlying investment choice is also regulated by law in that they must comply with the Prudential Investment Guidelines for retirement funds.

    Analysing the costs
    From a costs point of view, consider the following example on a R1000 per month debit order for a 36-year-old investor.

  • On a unit trust RA the maximum initial fee will be about R50 per month (excluding VAT), which includes about R30 per month commission. This will be levied for the duration of the investment.
  • On a life RA, the initial fee is about R15 500 (excluding VAT) and includes about R8700 commission. (The fee is usually deducted over the first 24 months of the policy.)

    This means that the unit trust RA would have to be in force for 310 months for it to incur the same initial costs as the life RA. We haven?t even begun to compare the annual ongoing fees levied on the different products.

  • For a 30-year-old investor, the initial costs on the life RA increase to almost R19 000 including R11 400 commission. (The term has increased to 25 years from 19 in the previous example.) In this case the unit trust RA would have to be in force for 32 years to generate the same initial fees.

    A final note
    Lastly, you may only access the funds once you turn 55. You then have to use at least two-thirds of it to buy a monthly pension. Costs on life RA?s are partly a function of the term of the RA, with higher costs for longer terms.

    In light of this, if you are going to use a life RA then there are very few instances (if any) where you should take an RA with a term that is longer than age 55. Once you reach 55, you can always extend it if you wish. This does not apply to a unit trust RA as the costs are not linked to the term in any way.

    For the record, the minimum premium on unit trust RA?s is R150 per month. If you are going to make use of an RA this year, then the funds need to be received by the relevant company by February 28, 2005 in order to qualify for the tax deduction in the current tax year.