I often witness a gun-shy response to the words “retirement annuity”. The pain of a product sold for profit by a commission-hungry salesperson, subject to terms and escalation with few asset class options, and the tale of woe handed down from father to child, only to be blindly upheld as the “trick” to miss.

One would have to concede that an industry previously measured by unregulated sales has probably been responsible for conditioning an entire generation of investors to run for the hills when hearing the words “retirement annuity”.

However, it is not the structure of the product that gave birth to the cynicism, but rather the contractual terms, escalating premiums, penalties, limited fund choice, and failure on the part of the advisor to marry the client’s investment objective with an appropriate solution.

In the “good old days”, the product providers paid sellers an upfront commission based on the term of the investment - the longer the term, the larger the commission. The longer the term, the more likely a default on a contribution. A default would result in a breach of contract, and lo and behold, a breach would give rise to a penalty. Importantly, these costs are attributed to the contract one entered with the product provider and are not born out of any complexities associated with the retirement annuity structure.

The truth is that investment planning involves a strategy, one that accommodates the journey of the investor’s life. The need for flexibility must be assessed and catered for. With the continued evolution of financial products and prices, it would be naive to take and hold a position from any one point in time to retirement.

Remove the contractual terms, and the naked retirement annuity evolves from ugly duckling to sophisticated swan, challenging the greatest cynic to review his stance and offering significant advantages in tax and estate planning.

What isn’t liked about an investment that:

• is protected from creditors;
• allows for tax-deductible contributions up to 27.5% of your taxable income (up to a maximum of R350 000 per year);
• gives you the flexibility of making a single and/or regular contributions and allows you to stop, start, or vary your contributions at any time without penalty;
• allows for tax-free growth on all capital within the structure (that means no CGT, no dividends tax, and no income tax). In today’s fiscal context, the latter is very significant,
• §on the death of the investor, lump sums received by beneficiaries are exempt from estate duty; and
• beneficiaries can also take advantage of tax-free amounts if contributions were previously disallowed (this will become clear by way of a later example).

OK, so where’s the catch?

Well, you can’t retire from the investment until the minimum age of 55 years – ultimately built-in protection from yourself! You are also limited to withdrawing 1/3 of the capital, which is subject to specific tax tables (as per below) and must utilise the remaining 2/3 for income by way of compulsory or living annuity. 

Is the restriction on liquidity a real showstopper?

The underlying questions must be, “Why would you want to access all the funds? What are you going to do with this money?” Investing for Retirement is about generating income from a growing capital base, right? Why then would you withdraw all your capital, erode it by paying tax, invest the balance in a fully taxable investment to effect growth and generate income, pay CGT, dividends tax and income tax, die and then pay estate duty and executors fees? It seems self-defeating.

Although dictated by legislation, liquidity restrictions prescribe the path you ought to follow, which is to preserve the tax-free status of your capital by transferring to a living annuity, prevent the eroding effects of CGT and dividends tax, limit income tax, and avoid paying estate duty where legitimately possible.

Further, the myth that retirement annuities can only invest in old-school, non-transparent portfolios can also be put to bed. It is now possible to have your retirement annuity invested entirely into a managed share portfolio, where you can actively participate in the management thereof. Besides actual bricks and mortar and other private interests, there are very few investment assets that you can’t access through a retirement annuity.

Overlay the ability to hold 45% of the portfolio value offshore, and you have a well-balanced platform to work off.

When it comes to estate planning, there are many administratively onerous and complex strategies offered to counter various eroding effects, be it an inter vivos trust, the use of a usufruct, donations, or a Section 4(q) – spouse nomination.

A retirement annuity offers a simple yet effective tool in this regard.

When the holder of a retirement annuity (RA) dies before retiring from the fund, the total fund value of the RA becomes payable as a death benefit. As per the Income Tax Act, the death benefit does not form part of the member’s deceased estate as it is distributed directly to the member’s financial dependants and/or nominees.

We can’t deny that the retirement annuity structure offers investors an effective vehicle to avoid the depletion of retirement capital due to taxes and estate duty. The compounded savings are significant if you take the time to run the numbers. The bad reputation may well have been warranted against the dressed-up retirement annuity tarts of the past, but in its naked form, the modern retirement annuity proves to be quite a catch!