We’re all familiar with the term “retirement annuity” and the significant tax benefits associated with this type of investment vehicle, but there are lesser-known details and benefits about RAs that all investors should know.
1. You can transfer your insurance RA to a mutual fund platform
If you’re sitting with an old school, insurance-based retirement annuity, you can transfer your investment to a unit trust platform, although there are a number of factors to consider before making a decision. The process of transferring your RA from one service provider to another is governed by Article 14 of the Pension Funds Act and may take several months. However, the transfer decision should not be taken as a knee-jerk reaction to high fees, poor investment performance or poor administration, but rather as part of a holistic investment strategy.
Insurance-based RAs are actually insurance policies and it is important to fully understand the fine print of the policy before making a final decision. When it comes to an insurance policy, there may be guarantees attached to the policy, or other benefits such as life and disability coverage which may disappear if you transfer your investment to a LISP platform. Additionally, there may also be penalties and/or charges for early termination of the contract which your current insurer should be able to provide a breakdown of. These penalties are designed to recover the initial commission and other costs when the policy was implemented.
Once you have a full understanding of the costs and penalties involved in transferring, your advisor should be able to prepare a cost-benefit analysis to determine whether the costs involved outweigh the long-term benefits of transferring to a new AR.
It is also important to note that the money invested in your RA is effectively housed in a tax envelope, which means that it will not attract tax when transferred from one approved retirement fund to another. If you transfer your RA insurance to a new generation RA which is hosted on a LISP platform, no expensive upfront commission will be paid to your financial advisor as with RA insurance. Your financial adviser will receive what is known as an “as you go” fee, which is essentially an advisory fee charged annually and calculated as a percentage of your invested capital.
2. You can use an RA to preserve your retirement benefits
When you leave an employer, it is almost always advisable to preserve your group retirement benefits rather than cash them out. While a preservation fund is an excellent vehicle to house such benefits, remember that it is not the only option available to you. . Transferring your group retirement benefits into a retirement annuity structure has significant benefits that must be weighed against the unique characteristics of a preservation fund.
If you transfer your funds to a preservation fund, you will not be able to make additional contributions to the investment. The only time you can add funds to a preservation fund is when they come from another approved retirement fund. On the other hand, if you transfer your funds into a retirement annuity, you can continue to contribute to it on a regular basis and make additional one-time contributions as circumstances allow.
Preservation funds offer investors a significant advantage in that they are allowed to withdraw all or part of their investment before the age of 55. Retirement annuities, however, do not allow investors to access their funds until age 55, so it is important to be sure that you will not need to access your capital before that age.
In all cases, no tax is due on the transfer of retirement benefits to a preservation fund or a retirement annuity.
3. You can have as many ARs as you want
You can open as many retirement annuities as you want, but you need to be clear about your reasons for doing so. Remember that you are allowed to invest up to 27.5% of your taxable income on a tax-deductible basis in an RA, with this limit applying to all of your contributions to an approved retirement fund. There is therefore no tax advantage to having more than one retirement pension.
If your RA is invested on a LISP platform, you can fully diversify your investment strategy – within the limits of Regulation 28 of the Pension Funds Act – within a single retirement annuity, which means that additional ARs will not create an opportunity for additional investment diversification. If possible, it therefore makes sense to contribute to a single retirement pension using an investment strategy that is perfectly aligned with your objectives and your investment horizon. There is an annual limit of R350,000.
4. RCAs are more tax efficient than TFSAs
When it comes to tax on investment returns, retirement annuities and tax-free savings accounts (TFSAs) offer the same tax efficiency for investors. No tax is paid on dividends or interest earned in an RA or TFSA, and there are no CGT consequences. The big difference between the two investment structures is that your contributions to an RA are tax deductible, whereas your contributions to a TFSA are made with after-tax money. Thus, TFSAs become attractive investment vehicles once you’ve maximized your tax-deductible contributions to an RA.
5. Your RA funds are protected from creditors
If you are declared insolvent, Section 37B of the Pension Funds Act provides that your retirement annuity funds are protected from your creditors, although this does not mean that your RA funds are fully protected against the creditors. Under the law, certain amounts may be deducted from your pension fund money, including amounts owed to Sars and amounts due and payable under the Divorce Act and the Maintenance Act.
6. Your overpayment will be carried forward
Although your tax deductible bonuses are limited to R350,000 of your taxable income per year, this does not mean that you cannot invest more than this in a tax year. Indeed, any excess contribution is carried over to the following year and can be used for tax deduction purposes in that year. The advantage is that the overcontribution will always benefit from an investment growth, even if the tax advantage will not be acquired until the following year.
7. Your RA funds are not subject to inheritance tax
The money invested in your retirement pension is not part of your deceased estate and therefore will not be considered for inheritance tax. Indeed, the distribution of the benefits of your pension fund in the event of death is the responsibility of the trustees of the fund who are required to follow the procedure provided for in section 37C of the law on pension funds. Under this legislation, the trustees are required to determine who your financial dependents are at the time of death and distribute the funds in accordance with their determination. Therefore, the executor of your deceased estate does not administer non-estate benefits from your retirement fund.
8. You can use your RA to reinvest your tax returns
An effective way to use your retirement pension is to reinvest the tax returns you receive from Sars. At the end of the tax year, you will need to submit your IT3 certificate to Sars as part of your e-filing providing proof of the contributions you made to your RA during that tax year, after which Sars will refund the tax to you. on these contributions. You can then use your Sars refund to complete your RA in the following tax year.
9. You can stop contributing to your RA without being penalized
Mutual fund retirement annuities are transparent and flexible investments that, unlike insurance ARs, allow investors to fully customize their contributions. This means you can set a contribution fully aligned with your financial capacity, and you can adjust the level of contribution up or down as your situation changes. You can choose to contribute monthly, quarterly, semi-annually or annually, with the added benefit that you can make one-time lump-sum contributions whenever you want. This makes RAs very attractive to those who earn irregular income or who earn intermittent commissions or bonuses.