Top 10 Things You Should Know About a Retirement Annuity
1. What is a Retirement Annuity?
A Retirement Annuity (RA) is often referred to as a "policy". Legally, an RA is not a policy. When you take out an RA, you are, in fact, signing up for membership of a pension fund, which is administered in terms of the rules of the fund and governed by the Pension Funds Act.
2. Tax advantages of a Retirement Annuity
One of the main reasons to use an RA is the tax advantage, both in the build-up to retirement, as well as in retirement. One tax structure applies when you use an RA to save for retirement, and another when you use the proceeds of an RA to buy an annuity (a pension).
3. The term of a Retirement Annuity
The period (term) for which you sign up for a life assurance RA is one of the issues over which you must take great care. As a result of bad advice from often unscrupulous financial advisers and representatives of the life assurance industry, many people have, to their detriment, signed up for membership of RA funds for excessive terms.
4. The costs of a Retirement Annuity
There will always be costs associated with investing. The issue is the quantum of the costs and whether you are receiving value for money.
5. Investment choice
Consumers are being offered more and more investment portfolios. The choice can range from a simple managed portfolio with capital guarantees, invested across asset classes and in which you have no say in the investments, to a "fruit salad" of unit trust funds which you must select.
6. Preserving your retirement savings
If you leave or lose your job, you can transfer your retirement savings from an employer-sponsored fund to an RA.
If you leave an employer-sponsored pension or provident fund, you may have a number of choices. These are:
a. You can take the cash, which will be taxed at your average rate of tax, and the first R1 800 will be tax-free. The average rate used will be the higher of the average rate in the tax year in which you leave your employer or the average rate in the year before your departure.
b. If the rules of the fund permit, you can leave your retirement savings where they are and become what is known as a deferred pensioner. You will use the money to buy a pension when you retire, but neither you nor your previous employer will be able to make further contributions to your savings. You will, however, receive growth on your investment. There are no tax or cost consequences to deferring your pension. You will not be able to access the money until the date of normal retirement.
c. If the rules of the fund permit, you can transfer your accumulated retirement savings to a fund sponsored by your new employer. There will be no tax or cost implications to transferring your savings. You need to check whether your years of membership of the previous fund will also count with the new fund.
d. You can "warehouse" your retirement savings in a retirement product sold by a financial services company. You have a choice between a preservation fund or an RA fund. No tax is payable on the transfer (trans-location) of your savings to a preservation fund or an RA. However, you will incur investment costs, which can be as high as six or seven percent of your initial investment, and up to 2.5 percent a year thereafter, which is likely higher than the ongoing costs.
7. Protection from creditors
A limited number of institutions or people may claim money invested in your RA. They include SARS in the case of unpaid taxes and a previous spouse, but then only in terms of a court-approved divorce settlement.
8. What happens when you die
When you take out an RA, you should be asked to name a beneficiary or beneficiaries.
9. Should you include risk assurance cover?
You can combine risk life and disability assurance with an RA in a single policy. (No risk assurance can be linked to a preservation fund.) There are advantages and disadvantages to doing this. You need to consider the following issues:
a. You can claim risk assurance premiums attached to an RA against your taxable income. However, you may still not exceed the limits for tax-deductible contributions to RAs. This means that in future when you may want to increase the savings portion of your RA, the premiums for the risk cover may no longer be claimable. So, you can only benefit from the tax deductions while the combined premium is less than the tax-deductible limit.
b. On death, the life assurance benefit of an RA is taxable because the total contributions have been claimed as a tax deduction. The proceeds of a free-standing risk life policy are not taxable in the hands of your dependants, beneficiaries or estate. This is because premiums paid for such a policy cannot be claimed as a deduction against your taxable income.
c. You cannot decide how the life benefit attached to an RA will be distributed. Although you may name beneficiaries, the proceeds must be distributed to dependants in terms of the Pension Funds Act.
10. Your rights
RA funds have to be approved by SARS and must be registered with the Financial Services Board (FSB) in terms of the Pension Funds Act. This Act provides you, as a member of an RA fund, with a fair amount of protection. You are also afforded protection under the Long Term Insurance Act, because in most cases when you join an RA fund you indirectly become a life assurance policyholder as well.