When one considers the merits of investing on your own or in a unit trust via a retirement annuity, the numbers definitely favour the second approach, says Pieter Willem Moolman.
The amount of additional growth needed per year for your own portfolio to overcome the tax benefits provided by a retirement annuity, or RA, is substantial.
It is clear that in most cases and at different taxable income levels you would be better off making use of an approved RA structure with its tax deductibility benefits rather than trying to build your retirement wealth with after-tax monies.
If we assume the same growth rates and cost structures for both approaches, the tax advantage of RAs usually relates to better performance.
If you earn R300 000 per year and you invest in your own portfolio, it will need to grow by 3.5% per year more than an RA investment! This is a very difficult benchmark to beat, especially with the advent of modern unit trust based RAs.
If you add costs into the equation, it is likely that your own portfolio will be cheaper than an RA, but it’s possible to get low-cost RAs that invest in unit trusts. Some companies even offer the RA for free provided you invest in their unit trusts.
Unfortunately RAs have a stigma attached to them because of how they were marketed in the past. Assurance companies sold very expensive RAs that paid insurance agents massive upfront commissions and delivered very poor growth.
The actual investment portfolios were so vague and the investment reporting was so poor that you had no idea what was actually happening to your money.
The situation was made worse by the fact that you could not move your RA to another company or cancel the investment without paying even more costs.
In the development of the unit trust industry, new product providers have started offering low-cost RAs that invest exclusively in unit trusts.
The reporting is much more transparent and the costs have reduced substantially. In addition, the laws around these products have changed, which means you can now move your RA – albeit with a bit of difficulty – between product providers.
The result is that you are now able to derive the full tax benefits of RAs without having to pay massive costs.
There is a downside to RAs, but it can also be seen as a positive. Once you start a retirement annuity, you cannot access your capital until you are 55 years old.
At that time, you will be able to get a portion of your capital as a lump sum while the balance will need to be invested – preferably in a unit trust based living annuity.
You can draw a monthly income from the living annuity until the money is depleted or you can leave it to your beneficiaries in the event of your death.
Even if you have financial problems, you cannot access the money in your RA until you are 55. The upside is that your creditors also cannot touch this money.
In addition, you cannot transfer your retirement or living annuity to an offshore retirement fund if you emigrate. You will only be able to move the income from the living annuity, but not the capital.
I believe RAs have an important role to play in any working person’s financial planning. With all the new legislation and transparency offered by unit trust based RAs, I have little fear of recommending them to investors.
Unfortunately, the old fashioned RAs still exist and these are not good investments. My recommendation is to invest in products offered by specialist investment companies and to make use of a qualified financial planner.
Pieter Willem Moolman is the owner of PWM Financial Management in Port Elizabeth. Visit www.pwmfb.co.za or phone 041 582 3034.