Pump up your investments! Levelling up at the Financial Gym – Programme for week 3, Reps x1, Exercise - Understanding Retirement-Annuities (Exercise time ~ 10mins)

In our two most recent blog posts, we have challenged you to increase the amount you are putting into your savings. To help you do this, we have been explaining the 101 of tax efficient investment options that you should be using. First, we looked at Tax-Free Savings Accounts, next we covered Endowments, and this week we are looking at Retirement Annuities!

1. Retirement Annuities – What Are They?

A Retirement Annuity (RA) is a long-term retirement savings vehicle designed to help individuals accumulate wealth for their retirement in a tax-efficient manner. In South Africa, RAs are regulated by the Pension Funds Act, and contributions are tax-deductible, making them a popular choice for self-employed individuals and those who want to supplement their employer-sponsored retirement funds e.g. Pension and Provident Fund contributions by your employer as part of your Employee Benefit Scheme.

Unlike pension or provident funds, which are usually offered by employers, an RA is a personal retirement savings plan that an individual contributes to voluntarily. These contributions can be invested in a range of assets, including equities, bonds, property, and cash, in line with Regulation 28 of the Pension Funds Act, which requires diversification within the investments chosen for good risk mitigation and healthy investment management.

2. Key Features of Retirement Annuities

• Regulation and Protection: RAs and Pension Funds are governed by the Pension Funds Act and regulated by the Financial Sector Conduct Authority (FSCA), ensuring compliance and security. This means that companies offering RAs must comply with standards, making your investment safer.

  
  

• Tax Deductibility: Contributions up to 27.5% of taxable income (capped at R350,000 annually) are deductible from tax. This tax benefit represents a massive saving over a lifetime of investing. Note that contributions to a pension or provident fund are also factored into determining the available limit should you choose to “super-size” your monthly retirement contributions through an RA.

  
  

• Preservation Rules: Funds cannot be accessed before the age of 55, except under specific conditions such as permanent disability or emigration under prior tax rules.

  
  

• Prudent investment allocation: RA investments are subject to Regulation 28, which limits excessive risk exposure by capping asset allocations to higher risk investments, unlike Unit Trusts and Endowments that have no such limits on the available assets and funds you can invest in.

  
  

• Annuity Payouts: At retirement, only one-third of the fund may be withdrawn as a lump sum (the first R550 000 will be tax free!), while two-thirds must be used to purchase a living or life annuity for a steady income stream.

  
  

3. Benefits of Retirement Annuities

• Tax Efficiency:

  • Contributions reduce your taxable income. This means more money for you.

  • Growth within the RA is tax-free (no Capital Gains Tax, dividends tax, or tax on interest).

  • Lump sum withdrawals at retirement are taxed according to the retirement tax table, which allows that the first R550 000 will be tax free. Amounts above this limit will be taxed according to the regular tax tables.

  • Two Pot System: You will have access to a portion of your RA (once a year out of the “Savings Pot,” withdrawals are taxed) before age 55. This way you will have access to funds in an emergency without needing to “cash-in” your RA. One Third of your monthly contributions are allocated to the “Savings Pot” while the remaining Two Thirds will be allocated to the “Retirement Pot” that is accessible only after age 55. Please refer to our previous post on the Two Pot System.

    
    

• Compulsory Savings Discipline:

  • Ensures long-term retirement savings that cannot be accessed prematurely, leading to financial security in late in life.

    
    

• Flexible Contributions:

  • Unlike employer pension funds, you can adjust contributions as and when needed.

  • Any contributions above the 27.5% tax deductible annual limit will be seen as Disallowed Contributions and will serve as a “credit” at retirement. Income received after retirement will be deducted from this “credit” and will be tax-free. Once the disallowed contribution “credit” has been depleted, your income will be taxed as per the normal tax tables.

    
    

• Estate Planning Benefits:

  • RAs do not form part of your deceased estate, meaning no estate duty applies, ensuring financial security for beneficiaries. However, any disallowed contributions will be a deemed asset in your estate for estate duty purposes.

    
    

• Flexibility in the choice of Investments:

  • Investors can choose different fund portfolios managed by a various asset managers, tailored to their preferred risk profiles and investment objectives (within the requirements of Regulation 28).

    
    

4. Obligations When Investing in a Retirement Annuity

• Minimum Contribution:

  • Some RAs require a minimum monthly, annual, or lump sum contribution.

    
    

• Preservation Until Age 55:

  • Funds cannot be accessed unless under specific circumstances such as permanent disability or emigration (for applications before 1 March 2021).

    
    

• Annuity Purchase Requirement:

  • At least two-thirds of the accumulated value must be used to buy a retirement income product (annuity).

  • You can purchase a Life Annuity that will guarantee your retirement income for life based on the amount you are investing. The downside to this is that there will not be an investment value that pays out to your estate at death (if you do not have a guaranteed term selected). If there are still a few years left of the Guarantee Term at death, the income will be paid-out to your beneficiaries for the remaining years.

  • If you purchase a Living Annuity, you determine the percentage income you receive annually based on the amount invested. While this option is more flexible in managing the income you receive, you do run the risk of running out of capital should your income percentage annually exceed the annual rate of return earned within the investment. At death, the remaining investment value will pay out to your estate or beneficiaries.

    
    

• Compliance with Regulation 28:

  • The investment portfolio must comply with asset allocation limits to manage investment risk.

  • Government determined that allocation to “risky” equity assets must be limited within Retirement Funds to protect investors against taking on too much risk and therefore possibly losing investment value over time.

  • The younger you are, the more risk you can take in fund choices to ensure long-term investment growth.

    
    

• Administration Fees:

  • Fees may vary depending on the RA provider and investment portfolio, affecting long-term returns.

  • Make sure that your adviser ensures that there are no penalties when adjusting monthly contributions as well as ensuring that platform fees, fund management fees and other related fees are as low as possible. Fees will affect your annual net return and ultimately affect your retirement value over time.

    
    

5. Commonly Asked Questions About Retirement Annuities

Q: Can I withdraw my RA before age 55?

• Generally, no, except in cases of permanent disability, emigration (for older applications), or when the total fund value is below R15,000 or where you access the “Savings pot.”

• As mentioned, you can however access the “Savings Pot” once a year.  The minimum withdrawal amount should be R2 000 while there are no maximum limits to the amount you can withdraw.

  
  

Q: What happens to my RA if I pass away?

• The value of the RA is distributed to beneficiaries as determined by the fund trustees under section 37C of the Pension Funds Act.

  
  

Q: What happens at retirement?

• You can withdraw up to one-third of the savings as a lump sum (taxable) and must use at least two-thirds to purchase an annuity either through a Living- or Life Annuity.

  
  

Q: Can I transfer my RA to another provider?

• Yes, RAs can be transferred to another approved retirement annuity fund but surrender penalties may apply.

  
  

Q: How are withdrawals taxed?

• Lump sums are taxed according to the retirement lump sum tax tables, while annuity payouts are subject to PAYE (Pay-As-You-Earn) tax.

• The first R550 000 will be tax-free. Amounts above this limit will be taxed according to the regular tax tables.

  
  

Retirement annuities are an effective, tax-efficient way to save for retirement, particularly for self-employed individuals or those looking to supplement other retirement savings. With strict preservation rules and compulsory annuitisation, RAs encourage disciplined saving, ensuring financial security in retirement. Understanding the tax benefits, investment restrictions, and obligations associated with RAs helps individuals make informed retirement planning decisions.

Join us in our next article, where we express an opinion on the upcoming South African 2026 budget. We will explain how it will impact you directly as an individual, the implications for various sectors and more broadly the impact on the South African Economy generally.

Have any questions for us on this blog post? Please send them to us at info@zenmunni.co.za

If you are struggling with knowing how to invest, or have too much debt, call us 087 183 5012 or WhatsApp us on 076 451 6944, or email us at info@zenmunni.co.za We are FAIS and NCR registered, and we can partner with you to grow and build your wealth.