How to know if your retirement strategy is still on track

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By: Julie Anderson and Damian Johnson , Overberg Asset Management

There are several ways to build up your wealth and plan for retirement. Two common South African strategies involve investing in a retirement annuity (RA) and investing in a discretionary investment (DI). The prevailing view amongst many financial advisors within the industry seems that an RA is a preferable route, because of the tax efficiencies it allows when saving toward your retirement age. This is indeed an advantage however, there are other key factors to consider – the impact of which may significantly outweigh this tax benefit.

At Overberg Asset Management, we have access to a distinctive, industry-focused calculator that can forecast the impact of the above, and many other factors. It can show that, depending on your financial circumstances (and perhaps contrary to popular opinion), a discretionary investment strategy can potentially be significantly more beneficial throughout your lifetime. When assessing the options, it is necessary to gain an understanding of the two investment structures and the inherent pros and cons of each.

What is a retirement annuity?

A retirement annuity is an official retirement savings vehicle that is governed by the regulations of the Pensions Fund Act 24 of 1956. These regulations place certain restrictions on both the asset allocation decision (Regulation 28) and the extent to which you can access the funds. The earliest you may access a portion of the investment is at the retirement age of 55. No withdrawals are permissible until retirement age (with a few exceptions). Both the pre- and post-retirement scenarios should be reviewed.

Key considerations of an RA pre-retirement:

  • The contributions made to an RA are tax deductible: Up to 27.5% of your remuneration/taxable income (limited to R350,000 per year).
  • Both the income and capital gains earned within the RA are not taxable.
  • Upon emigration, access to the investment can only be obtained after demonstrating to SARS that you have been a tax resident of another jurisdiction for three consecutive years (in other words, there’s a three-year waiting period).
  • Regulation 28: This regulation effectively places limits on one’s asset allocation decision, which could be the primary determinant of future potential returns.
  • Regulation 28 stipulates that no more than 75% of your capital can be invested in equities.
  • As of February 2022, the maximum exposure towards offshore assets is limited to 45% for your Retirement Annuity. This significantly inhibits the extent of exposure to a greater investment universe, and potentially superior investment opportunities. It also limits the degree of geographical diversification in a portfolio

Key considerations of an RA at and post-retirement:

  • When you have reached retirement age or want to access the funds in your RA at a later stage, the RA must be matured. At maturity, you will only be able to access a maximum of one-third of the value of capital, as a lump sum withdrawal and the remainder must, in terms of regulations, be used to purchase an annuity. Alternatively, if no lump sum is withdrawn, then the full investment amount must be used to purchase an annuity. This can either be a living annuity or a life/guaranteed annuity or a combination of both. A living annuity is more common and lasts until the investment is depleted, which is considered below.
  • The exception to the above is that the full amount of the capital sum can only be withdrawn if the investment is lower than the de minimis value, currently at R247,500.
  • A lump sum withdrawal may be taxable. Currently, accumulated withdrawals of R500,000 or lower are not taxable (subject to certain exceptions) however, larger sums are taxed according to a specific tax table and the tax payable thereon may be considerable.
  • An income of between 2.5% and 17.5% of the investment sum must be withdrawn annually. This sum can be paid monthly, quarterly, or annually. The drawdown rate you select is an important decision as this can only be changed once a year at the policy anniversary date. These restrictions may create difficulties should your financial needs change during the year.
  • The annuity income is subject to tax – taxed as normal income at a marginal tax rate. For individuals that fall into the higher tax brackets, this may equate to a significant tax burden throughout their retirement.
  • The annuity income will be paid in South Africa in Rands.
  • You may only access all the funds in your investment if the capital sum is below a certain level, currently R125,000, and this withdrawal may be subject to tax.

It is therefore critical for investors to note that when investing in an RA, they are also effectively committing to enter an annuity contract at retirement. The tax burden both at and following retirement can be substantial. These are also regulated investment vehicles and are therefore subject to regulatory changes from time to time, which may or may not be favourable to investors.

What is a discretionary investment?

A discretionary investment (DI) refers to an investment using “after-tax” or discretionary income. The underlying investment vehicles can be unit trusts, share portfolios, offshore products, etc. As the name suggests, an investor can use their discretion to invest their funds with minimal restrictions, according to their risk profile, investment strategy, and financial goals.

Key considerations of a DI:

  • Unlimited contributions and withdrawals at any time. However, contributions are not tax deductible.
  • Dividends and interest earned are taxable, the annual interest exemption would however apply (local interest earned: currently R23,800 for persons under 65 and R34,500 for those over 65).
  • Capital gains tax (CGT) will be levied upon capital growth when equities/investments are sold (for switches and withdrawals). The current annual CGT exclusion of R40,000 would be applicable.
  • There are no restrictions on offshore exposure and investors can utilize their annual discretionary allowance of R1 million and/or annual foreign investment allowance of R10 million (subject to tax clearance) to fully invest offshore.
  • Upon emigration, there is no waiting period for funds to be sent offshore (subject to tax clearance). Investors can access offshore funds immediately.
  • Offshore investments do not have to be repatriated to South Africa.
  • There are no restrictions on the asset allocation decision. Investors can, therefore, gain a greater degree of exposure to attractive global investment opportunities, with greater potential.
  • An offshore investment in hard currency can serve as a Rand hedge. Over the last 10 years, the Rand has depreciated by approx. 7% against the US Dollar and approx. 4% against the British Pound per annum. The effect of such exchange rate movements can therefore be compelling, and possibly net positive on the Rand returns for long-term South African investors.

How should investors choose what is best for them?

To ascertain the best investment strategy for your retirement, it is recommended that you seek advice from professionals. When comparing whether a Retirement Annuity or Discretionary Investment will be more beneficial for you, the following two key factors should be analysed first:

  1. The impact of potential returns on the investment: An RA is subject to investment restrictions in terms of Regulation 28. These associated limitations may potentially result in lower returns throughout the investment lifetime. It is important to remember that the investment horizon for your retirement is a very long time frame. Even a small differential in returns could have a sizable impact over time, given the effects of compound growth.
  2. The tax implications both at and after retirement: A lump sum withdrawal from an RA of more than R500,000 will be subject to tax. Additionally, the subsequent annuity income received periodically will be taxed at your marginal income tax rate. This is a crucial consideration if you are in a higher personal income tax bracket. The total of this tax burden can be substantial – it could negate much of the tax benefit gained from an RA during pre-retirement years.

Fortunately, Overberg Asset Management has access to various brilliantly developed, distinctive, industry focused calculators, one of which will facilitate forecasting whether a RA or DI will be more beneficial for you. This calculator can cater for all applicable taxes, costs, investment returns, etc. The comprehensive results will show the full breakdown of forecasted annual cashflows, the tax implications, and more, over the full investment period (including retirement). It is important to consider various scenarios when using the calculator, and these scenarios can be determined instantaneously.  

Contact Overberg Asset Management to book a free consultation with one of our Wealth Managers to benefit from this highly specialised financial offering. This offer is available to all Overberg Asset Management clients or prospective clients looking to invest R1 million or more either locally or offshore.

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  • All writers’ opinions are their own and do not constitute investment recommendations or financial advice. Speaking to a qualified wealth and investment professional is crucial before making financial decisions.
  • ‘Overberg Asset Management (Pty) Ltd. is an authorised financial services provider: 783’ established in 2001.

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