Retirement annuties: all the facts

Do you know who “invented” the idea of retirement?

In 1881, Chancellor Otto Von Bismarck of Germany was facing a huge problem. Marxist unrest was spreading across Europe and some of his own compatriots were calling for socialist reforms. To combat this, Bismarck created a social program whereby the national government started paying a pension to older Germans.

Legend has it that they chose 65 as the magic number for retirement because it was Bismarck’s own age at the time. This fable does not hold up though. Fact is that Germany initially has chosen 70 as its retirement age. They did not lower the age to 65 until long after Bismarck was dead and for a very cunning reason. The average life expectancy in Germany was 65 years. A nice little cost savings exercise. Fast forward to the year 2019 and the norm is still to retire between the ages of 60 and 65 in cases of formal retirement.

Although our life expectancy may be higher these days, we are facing another demon. The elephant in the room is not having enough capital available at retirement.  We all know someone who has retired and are struggling to make ends meet. For most of us, it will be nice to get out of the rat race one day, but some of us will have to learn to get along with less cheese. This is a quote of an anonymous person: “Retirement: no job, no stress, and no pay!”

Saving for retirement is a journey

One of the long term saving goals in any personal financial plan is saving for retirement.

The billboard perception of retirement is a working life until 60-65, and then you retire and enjoy your last years travelling extensively. For a lucky few, this may be a reality, but doom and gloom and easy math’s paints a much darker picture.  There is an alarming difference between this perception and reality for current and future retirees. Google “why people won’t be able to retire” and see if you do not go into a state of panic. Some of the reasons for this retirement crisis are:

• Start saving too late towards retirement
• Underestimate how much retirement will cost
• Not paying off debt before retirement
• Not reviewing your investment on a regular basis
• Cashing in savings before retirement
• The phasing out of defined benefit funds’
• Longer life expectancy
• Medical expenses at retirement

Unless you win the lotto or inherit from your rich family, you will have to save for your own retirement. This is a definite long-term savings goal in any personal financial plan.

The realities of saving for retirement differs

• If you work in an environment where there is a formal retirement scheme, you are halfway there. The question that remains though, is whether you will save enough through your formal retirement funding to reach your retirement income goal and if not, what other investment vehicles are available that is ideally suited for retirement savings? 
• On the flipside, you’re either self-employed or do not have access to the traditional pension or provident funds schemes. How do you save for retirement? 
• As there is no comprehensive South African pension system provided by the state, South African citizens that do not meet the requirements of the old-age pension are limited to employment-based or private pension options.
• Needs versus wants: there is the fine balance between your savings goals and your personal financial plan.

What is a retirement annuity and how does it work?

If you do not have access to a pension or a provident fund, how do you save towards retirement? You could stuff your savings under your mattress, buy a second property to rent out, or even try your hand at shares on the JSE. There is no shortage in investment options. The trick is however to find an investment vehicle that complements the savings goal in your personal financial plan. The retirement annuity fits this role perfectly.

A retirement annuity (RA) is a retirement fund in terms of the Pension Funds Act. This is a tax effective investment vehicle designed for individual investors (as opposed to employees who contribute to a workplace retirement fund). A retirement annuity is ideal for people who:

• are self-employed
• don’t have access to a work-place pension or provident fund through their employer
• want to supplement their pension or provident fund savings
• earn significant amounts of non-pensionable income (e.g. interest and rental income)

A retirement annuity is a long-term investment offered by an insurance company. This type of investment allows you to save for retirement.

You can retire from a RA at earliest age 55. Then you have the option to withdraw a maximum of one third of the fund value. With the remaining fund value, you are obliged to purchase an annuity income.

• Any lump sum taken is subject to lump sum tax in terms of Schedule 2 of the Income Tax Act
• Any annuity income is taxed at normal personal income tax rates
• The first R500 000 of the lump sum is a tax-free.  This is subject to no previous lump sums received

If you pass away before actual retirement, the trustees of your retirement fund will decide how to distribute the death benefits between your nominated beneficiaries and financial dependents as per Section 37C of the Pension Funds Act.

Benefits of a retirement annuity

1. Tax benefits

One of the biggest benefits of a retirement annuity is the tax breaks and deductions. Investing in a retirement annuity means:

• There is a tax relief on contributions. You can deduct your contributions from your income tax due at the end of the year (up to a certain limit). Contributions are tax-deductible up to 27.5% of gross remuneration or taxable income, whichever is the highest. This applies to your total contributions to pension, provident and/or retirement fund and is subject to an annual cap of R350 000
• Any investment returns (dividends, income and capital gains) within the fund is tax-free
• At retirement up to one third of the investment value can be taken as a lump sum, with the first R500 000 taxed at 0%
• At retirement, if your investment amount is less than R247 500, you can withdraw the full amount
• When you retire and convert the retirement annuity to a living annuity, all investment returns in the living annuity is also tax -free

2. The power of compound growth

When you are investing over a long period and have a disciplined savings plan, your invested funds start to work for you from the day you invest. The benefit of compound interest means that you earn growth on the growth. Therefore, the longer you invest, the bigger the advantage. Over 30 years, more than 65% of the value of your retirement annuity could come from this compound growth alone.