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All you need to know on RAs (Part 1)

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All you need to know on RAs (Part 1)

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We all hope to have enough money to pay for our monthly expenses (and some extra for fun stuff of course) once we hit retirement. No one wants to eat dog food 3 times a day. Except your dog of course. But I digress…
Retirement Annuities are one of a number of different products designed for the sole purpose of helping you achieve financial freedom in retirement.
And because having enough money in retirement means that the Government doesn’t have to look after you, many of these retirement products also come with some really nice tax breaks. Think of it as the Governments way of saying thank you for looking out for your future.
In this easy to follow guide, we are going to be looking at everything Retirement Annuity. We will start with the basics, and then cover some of the advanced topics too.
You are going to be a Retirement Annuity guru in no time!

What Is A Retirement Annuity (RA)?

A lot of people don’t are under the impression that a Retirement Annuity (or RA) is a mystical and complicated beast which only the experts fully understand. The pros love to throw jargon around, and this means many people lose interest pretty quickly and believe they will never understand what an RA is or how it works.
So let’s dumb it right down, because a RA is actually pretty easy to understand.
A Retirement Annuity is basically a… bucket. 

Wait, what? 
Yup an RA is like a bucket. And on it’s own it doesn’t do much – that is until you put some stuff into the bucket. It’s kind of like a bank account is just a number, but it becomes useful once you put some money inside of it.

So what can you put inside of an RA?

Well, to continue with the bucket analogy, you can put some investment blocks inside of your RA bucket.

These investment blocks are pretty much just like any other investments – Unit Trusts, Cash, Bonds etc.

To really dumb it down, it looks a little something like this – just a bucket with some blocks in it…

Now the reason you want to put your investment blocks inside of an RA bucket, is because once inside the RA bucket, these investment blocks enjoy some pretty awesome tax breaks. You do not pay Income Tax, Capital Gains Tax or Dividends Withholding Tax inside of an RA.
And there is another great tax benefit to Retirement Annuities – you do not pay any tax on the money you contribute to a RA. The cool kids will tell you that contributions to a RA are “tax deductible” (more on that in the next section)
That is why many people use retirement annuities to save for their retirement – by not paying tax on your contributions or on your RA investments, it means you come out with more money when you retire. More money is good.

So as you can see, the product is not maybe as complicated as many would have you believe?

Before moving on,.let’s quickly summarise what an RA is 

RAs In a Nutshell

Retirement Annuity meaning – A RA (Retirement Annuity) is basically a retirement savings account which holds some investments. The investments inside of an RA can be in the form of Unit Trusts, ETFs, or even Cash.

The reason you would want to put your investments inside of an RA are due to the tax protection you get by holding them inside of an RA and because the contributions you make to an RA are tax deductible.

Retirement Annuities v Unit Trusts

Many people confuse Unit Trusts and Retirement Annuities, and that’s probably because the two are often used together. However there is a pretty big differences between the two which is explained below.

Unit TrustRetirement Annuity
A unit trust is an investment product which you can buy.

Depending on the type of Unit Trust, your money will then be invested into one or more asset classes (Cash, Bonds, Equities, Property or Commodities).

Unit Trusts spread your money (by investing in different asset classes, or countries, or in different companies) meaning that your investment is diversified

A retirement annuity is just a bucket, which by itself doesn’t do anything.

To turn a retirement annuity into something useful, you need to put something inside the bucket. The investments you put inside are then protected from Tax.

One of the things you can put inside your Retirement Annuity bucket are Unit Trusts

A good way to visualise the difference between an RA (Retirement Annuity)and a UT (Unit Trust) is to think of them as a chocolate (Yum!)

The RA is the chocolate wrapper (which protects the chocolate from dirt, keeps it fresh and stops the Government from eating some of it (Tax). When people talk about Retirement Annuities, they mean the wrapper. But remember, a wrapper by itself is just a wrapper – we want the goodness inside!

A Unit Trust is an example of some of the deliciousness you can find inside of a RA wrapper. The other types of chocolates include ETFs or cash savings.

Tax Treatment Of Retirement Annuity Contributions

There is no tax payable on the investments inside of a Retirement Annuity. And that’s a really great feature. But there is another great tax benefit related to contributions you make to a Retirement Annuity.

Retirement contributions are what is called tax-deductible. In short that means that you do not pay tax on the money you invest into a Retirement Annuity. 

In the view of SARS, you only earned (and therefore are only taxed on) the money you receive after you subtract (or deduct) the contributions you made towards your retirement annuity .

Tax treatment of your RA contributions looks a little something like this

For example, if you earned R250,000 for the year, but you contributed R1000 a month to a Retirement Annuity (which is R12,000 for the year) you will only be taxed on R238,000. 

Because the contributions to an RA are tax deductible, it is like you earned less, and therefore you pay less tax. Less tax is good!

Maximum Tax Deduction

The RA contribution tax deduction can really work in your favour. But SARS generosity does have a limit…

There is a maximum amount you are allowed to deduct from your taxable income with regards to retirement contributions (and note that this maximum applies across all retirement product contributions including your company’s pension or provident fund as well as retirement annuity contributions).

The current legislation states that you can deduct a maximum of 27.5% of your remuneration or taxable income (whichever is higher), and no more than R350,000. 
This is best explained using some examples.

First let’s assume Daniel earns R400,000 a year and wants to work out the maximum he can contribute to retirement savings products.

Maximum Tax Deductible = Taxable Income x 27.5%
= R400,000 * 0.275
= R110,00
This means that Steve would be able contribute a total of R110,000 per year (or R9167/month) to a pension fund, or RA, and deduct this from his taxable income for the tax year. 
Instead of being taxed on earnings of R400,000 for the year, he would only pay tax on R290,000 (R400,000 – R110,000).

As another example, meet the future you earning a cool  R1.5Million a year. Let’s calculate the maximum tax deduction you would be allowed.

Maximum Tax Deductible = Taxable Income x 27.5%
= R1,500,000 * 0.275
= R412,500

In this scenario, the 27.5% of taxable income gives R412,500. But we must remember that there is a cap of R350,000 on the amount you are allowed to deduct. 
Because of future you’s supersized earnings, the R350k cap is breached (lekker problem to have!) and so the maximum tax deductible contributions is limited to R350,000 worth of contributions per year (or R29,167/month)  to a pension fund or RA.

Retirement Annuity – Minimum Investment Amount

Some RA providers require you to have either a minimum monthly amount, or a minimum lumpsum amount available to invest before they will let you open a RA with them.

For example a RA provider may stipulate that you need to invest a minimum of R500/month or have a lumpsum of R10,000.
For some people this may seem pretty steep. But fear not!

There are some providers which have no minimums, and they will allow you invest even R10 at a time. For example there are no minimum requirements if you invest in the EasyEquities RA.

Retirement Annuity Investment Rules

So, as we have seen from the above, SARS is pretty generous in allowing your contributions to be tax deductible, and also allowing the investments inside of an RA to grow tax free.
But nothing for nothing right?
So what is expected from you in return?
Well there are a few rules regarding the investments inside a Retirement Annuity. The legislation, or rules, around what is and isn’t allowed for the investments inside of a RA is known as Regulation 28.
Regulation 28 has quite a local is a lekker approach, and so the first rule it imposes is that no more than 25% of your investment is allowed to be outside of South Africa. 
You are allowed an additional 5% outside of South Africa, provided it is being invested into Africa. This takes the maximum amount of the investment allocated outside of South Africa to 30%. So all in all at least 70% of your RA needs to be allocated to South Africa.
Your investments inside of an RA are also limited in terms of which types of asset classes you can invest in. The main types of asset classes are: Equities (companies), Property, Bonds, Cash and Commodities.
Currently Regulation 28 says that you cannot have more than:

  • 75% invested into equities
  • 25% invested into property

Part 2 coming soon…

Article reposted with permission from Stealthy Wealth.

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Stealthy Wealth

Stealthy Wealth is planning to stop work and “retire” in 2030 at age 45. He writes about all the detail on getting there - including the plan to make it happen, the decisions along the way, investments he is making, the cost-cutting ideas, and any other randomness that pops into his head along the way. You can find more of his content at Stealthy Wealth

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