JOHANNESBURG — With investing in the stock market and ETFs having become easier in recent years, it may beg the question as to whether one still needs Retirement Annuities (RAs). This is something that popular personal finance blogger Stealthy Wealth has mulled over for quite some time. In this blog post, he revisists the topic and comes to the conclusion that he doesn’t like them. – Gareth van Zyl
By Stealthy Wealth*
I have been having the RA debate with myself pretty much since the day I started working1. But I have never taken the plunge.
There has always been something holding me back. Back when I started working I didn’t like the ridiculous fees. A few years later, it was the idea of being locked in to monthly contributions for decades which put me off.
Each time I made peace with my decision not to invest, and moved on.
But these days the fees are a lot more reasonable, and there is a lot more flexibility in a modern RA product. And of course I do not think there are many sounds sweeter than that of a tax rebate crashing into your account!
So I had another look see.
Still don’t like them!
Now before you rush off an cancel your Retirement Annuity, I must point out that, for many people, RA’s are fantastic products. The Tax benefits of an RA is hard to argue with, especially for those in the upper tax brackets (*sigh* maybe one day when I am big and strong…)
In fact, many of the reasons I don’t like RA’s are actually big advantages for most people saving for retirement.
Please also note that none of the below is financial advice, and these are merely my thoughts on why I do not think an RA is well suited to my personal plans and goals.
1. The money as stuck until you 55
The money you put into an RA is untouchable until you are 55 years old. There are exceptions such as if you emigrate, or via a court order in divorce proceedings – but I think trying to get your money out using either of these methods may be a little extreme…
Of course this limitation is a saving grace for many, as it forces people to only use the RA funds when they hit retirement (and not when they changing jobs, or if they get into some other sort of financial trouble) which, in general, is a good thing.
The problem is that this limitation is a little inconvenient for me and my plan to retire at age 45 – I can’t afford to have money stuck in the RA prison.
Interestingly, it seems that I am not the only one with this dilemma – this recent Twitter poll I put out seems to indicate that there are a fair amount of the blogs readers who are in the same retire-before-55-boat:
Are you planning on being financially free before age 55?
— Stealthy Wealth (@stealthy_wealth) November 2, 2017
A retirement annuity is a product (or a wrapper if you want to be fancy). And yes the more modern providers have very low fees – but there are still fees. With something like a TFSA or a normal discretionary investment account, there are a couple of providers with 0 admin/annual fees.
3. Government limits what you can invest in
All retirement products in South Africa have to be Regulation 28 compliant. Regulation 28 is basically a bunch of rules dictating how much pension products are allowed to have invested in some of the asset classes and geographies. For example no more than 25% is allowed to be offshore and no more than 75% in equities.
I can appreciate the thinking around this, as it is designed to protect people from doing stupid interesting things like putting their entire pension into African Bank. However I don’t like being constrained like this, and if I, for whatever reason, wanted to put everything into a Japanese Index Tracker for example, I don’t want the Pension Police stopping me from doing that.
4. Returns are less
History has shown that, over the longer term, the best performing asset class has been equities. So in order to maximise returns over the long term, if you have the risk appetite for it, it makes sense to be 100% in equities. The problem is the Regulation 28 stuff I mentioned earlier, doesn’t allow you to do this (maximum of 75% in equities remember).
So with only 75% in equities, it follows that over the long term, an RA will underperform a 100% equity portfolio. And then of course there are the extra RA fees as well, which will also detract from performance.
Based on my risk appetite and time frame, I want 100% equity exposure. An RA cannot give me this.
5. Government controls what you do at the end
Once you make it to 55 (or older) and you are ready to enjoy the benefits of your RA, Government again steps in with a rule book. This time they say that you are only allowed to take 1/3 of your RA as cash, and the rest needs to buy an annuity product.
For most this is probably a good thin,g and it is designed to protect people from themselves.
But again, personally, I don’t like being told where to allocate my investments.
6. Tax at the end
While RA’s give you a very nice upfront tax benefit, you give some of that tax back later on.
It kind of reminds me of when you used to get weekend homework. I always tried to get it done on Friday afternoon and not have the looming dread hang over you until you end up doing it on Sunday evening.
There is just something ominous about paying tax at the end.
For the 1/3 you are allowed to take out of an RA as a lumpsum, SARS gives you tax relief. As per the table below, which I painstakingly typed out copy-pasted from the SARS website, the first half a million is tax free. My main problem is that I already have a pension/provident fund with my employer, as well as a preservation fund from a previous employer. So the lumpsum tax relief will already be used across those products – any additional lumpsum from an RA would more than likely end up being taxed at 36%.
|Taxable income from lump sum benefits||Rates of tax|
|0 – 500 000||0% of taxable income|
|500 001 – 700 000||18% of taxable income above 500 000|
|700 001 – 1 050 000||36 000 + 27% of taxable income above 700 000|
|1 050 001 and above||130 500 + 36% of taxable income above 1 050 000|
With regards to the remaining 2/3’s – that must be used to buy an annuity. The income from that annuity will be combined with any other income and taxed accordingly.
7. Fees again
And of course the annuity product you are required to purchase when an RA matures will be provided by a financial institution. And a financial institution needs to make a profit. So they will charge fees/structure their product in a way that will, on average, leave them better off than you.
This means that all things being equal, you will be worse off than if you were able to invest the money yourself through a platform which does not charge any administration/annual fees.
8. The rebate is paid cack as cash
Wait, what? How is this a bad thing?
Well, cash is always tempting….
And I think that this is where a lot of people waste the benefits of an RA. The rebate arrives, and the new TV, or overseas holiday, or *insert expense that would not have been incurred without RA rebate here* is just too tempting. Personally I think the rebate should be paid directly to the RA provider to reinvest on the investors behalf – but that’s just me…
But of course there are those with the discipline to reinvest the rebate, and this is where the real benefits of RA’s are realised.
9. Laws can change
Tax laws, income brackets, rebates and exemptions are always changing. There is no ways of knowing what these will be like when I am old enough to cash out an RA. Yes there is a chance they could be better than they are currently, but they could always be worse. I don’t really like that kind of uncertainty.
At least with something like a TFSA, you know that the money invested will always be free of tax. (Yes I know nothing is 100% certain, but I find the likelihood of this ever changing to be as close to 0 as you can get, and if there was an attempt to do so, the litigation and appeals would last until well after I reach my sell by date.)
But on the other hand Darren…
As I mentioned, RA’s can be an excellent product for those on a more “normal” retirement path. So in the interests of presenting a balanced write up, I thought I had better at least link to an article pointing out the many advantages of a Retirement Annuity – you can read that here.
- Stealthy Wealth runs a personal finance blog documenting a 15 year journey to financial freedom.