Retirement annuities as an investment vehicle
If you think you know what a retirement annuity is, then you’re either selling them or a legal expert in annuities. The industry in South Africa is a whopping R 1.8-trillion in money being managed. Retirement annuities are complicated – and with reason.
Retirement annuities may be seen as a container or basket:
- You get to invest some money into funds that qualify to be put into the basket.
- If you do, you can get your tax back on the money you put in.
- The fund managers perform magic and then earn you tons of money (WHAHAHAHA!)
- When you retire, depending on the type of annuity, you get the money as a pension of sorts.
Many people make a monthly contribution to an RA. Some people save a large amount once off. In other words, some people have a recurring contribution, others have a lump sum that they invest in an RA.
In my opinion, the family of retirement products in South Africa (those that only allow for money access at 55) is more of a saving mechanism. What I mean by that is you’re forced to save money and you cannot withdraw it.
There’s so much to know, but here’s a couple of big words that you would need to know:
- Contribution: The amount of money that you put into the fund. Some funds/financial advisors require a fee to be paid on all money going into the fund.
- Annual fee – Note that 99.9 % of funds require annual fees – they charge this of the ENTIRE FUND VALUE.
- TER (total expense ratio) – this represents the fees charged for managing the fund, trading, legal and auditor fees. This is an annual charge based on your entire fund value.
- ETF (Exchange traded fund) – With minimal options, you could wrap your retirement annuity in an ETF. This is a fund that is electronically traded. I like to think of it as a set of rules. If a stock adheres to the rules, they’re in the basket. If they don’t they’re thrown out.
Retirement annuity terminology
Retirement annuities are complicated – how else will advisors make money than to obscure fees with complicated lingo?
There’s so much to know, but here’s a couple of big words to guide you through this article:
- Regulation 28 – This governs retirement annuities and includes laws. A few of these laws include (as of 2018):
- Less than 75% can be invested in shares/stocks
- 30% or less can be taken offshore (with an additional 10% in Africa)
- Policy retirement annuity – You sign a contract to pay an amount every month until retirement. If you default, you will need to pay severe penalties
- Financial advisor – this person goes between you and the fund and buys the RA for you. You pay him loads of money for doing nothing.
What could go wrong?
Overregulation and legal aspects
Retirement annuities are overregulated. This means that the fund managers and important people cannot take any big risks, and need to be audited for compliance. They also need to check that all the cost centres are in place – in plain English, they need to spend loads of money to make sure that they have their legal backs covered.
The industry has lots of people that require large salaries – auditors, actuaries, software developers, researchers, day traders and fund managers – just to name a few. The issue is that many funds charge insane amounts. I recently had a reader contact me and show proof of their RA taking fees of 4.5 % of all contributions and an annual fee of 1.92 %.
If you have a policy retirement annuity, you need to make monthly contributions to the fund. Make sure you are able to pay that amount of money for the rest of your life. If you lose your job, you legally lose loads of money in penalties.
What if you want your money now?
In short – nope.
What if you’re thinking of retiring early? Nope, that money missing in action until you’re 55 – unless you’re on early retirement for medical reasons.
How about using it to pay off debt? Nope.
Maybe you need it because you are getting divorced and your other half is demanding the money – well maybe depending on the specific laws governing it.
Types of investments and strategies
When you invest in a retirement annuity, it’s like investing in any other paperless asset. You hand over your money and get reports on how it’s doing. Some retirement annuities take existing funds and ‘wrap’ them in what is called an ‘RA Wrapper’.
Within an RA, you have the option to invest in funds and/or an ETF:
- Active fund – A fund where people are actively sitting and trading stocks and/or bonds
- Passive fund – A fund where they hold on to what they bought – the opposite of an active fund.
- ETFs – Rarely found in an RA wrapper, this seems to become trendy. The ETF tracks certain rules in the stock market. If the rules don’t apply, they will sell the stock and buy another one that adheres to the rules.
Concerning the different types of annuities that you would most likely need to buy, here are some options:
- Life annuity – The policy will cover you for the rest of your life for an amount. It’s more an insurance policy. IF you die, the company takes everything. Once you retire, you will start getting this money monthly
- Living Annuity- This is a savings fund. You save money and the money could run out. If you die, the money will be given to the beneficiaries. Once you retire, you can withdraw up to 27.5 % of the fund value. The rest must be converted into a living annuity, which is sort of like a savings account with a little interest.
- With-profit annuity – This type of annuity will make you share the profits of the annuity/fund depending on performance.
The pros and cons
Even with the complexity, you have pros and cons that you can weigh up if an RA is the right thing for you. If you would like to buy your financial advisor a holiday to Thailand regularly, please check this awesome post from Stealthy Wealth here.
- Your money cannot be touched – it can only be withdrawn under special conditions and after 55.
- It’s a forced way to save for retirement
- You get your tax back of all money put into the retirement annuity
- High fees means low (to negative) returns – RA’s are known as having high fees
- Regulation 28 forces you to invest 70% in South Africa, which is flat with little returns at the moment
- Massive penalty fees is payable on defaulting on payments if you hold a policy retirement annuity.
Quick tax overview
This article is not tax advice, but gives an overview of the asset class
Please speak to your tax advisor for your specific needs and analysis
For this section, I would like to give a special thank you to Andre Bothma (Twitter here) for his help and contribution.
As you would know, if you have an RA, you would be getting your tax money back – as an example, if you are in the 28% tax bracket, for every R 100 you put into your RA, you will receive R28 back in your pocket.
You can do this for your whole salary or a maximum of 27.5%, capped at R350 000 per tax year.
Note that you will be paying tax on this once you retire. Never think you will be free of taxes, SARS never sleeps!
Ways to invest
Always check the fees involved in transactions
Many financial advisors and brokers charge money to invest. They often charge a fee on the entire fund value. Make sure you are clear about the cost of investing.
Here are a few options for investing in retirement annuities:
- Direct – many companies offer a direct investment into an RA (such as 10x and Coronation). Also note that some may assign a financial advisor to you automatically, meaning your fees will go up
- Through a broker or financial advisor – Many people will use someone to help them manage their money, as they are not interested in checking this every year or decade. Make sure you use a certified FA and ask about fees.
- EasyEquities – though I do not endorse any company, it’s really simple and cost effective to do it yourself through EasyEquities.
Retirement annuities are fee monsters – they eat into your capital
Retirement annuities give you tax back, but you pay with high fees with low returns.
If your RA is giving you low fees and high returns, please let me know!