It makes sense to keep contributing to your retirement funds so as to reduce your taxable income, but there are various factors to consider before taking out a new RA.

I am 61 years old and qualify to retire from the Government Employees Pension Fund (GEPF). I have two retirement annuities (RAs worth R200 000 and R900 000. I would prefer to work until 65. Will taking another RA make good sense?

Dear reader,

Thank you for your question. A retirement annuity (RA) is an investment vehicle designed to house retirement savings. Contributing towards an RA allows you to reduce your taxable income and effectively reduce your income tax liability. Currently, you are able to contribute up to a maximum of 27.5% of your taxable income per year, subject to a maximum of R350 000 per tax year.

If you intend to work until age 65 and continue earning a taxable income, it makes sense to keep contributing to your retirement funds so as to reduce your taxable income while continuing to build your nest egg.

However, besides maximising your available tax deductions, there are a number of other factors that should be considered here.

These include:

  • The type of RAs you currently have in place: Old-school, insurance-based RAs generally have quite inflexible structures with higher investment fees, and it may be worthwhile investing in a unit trust RA which provides greater investment flexibility, more cost-effective fees and zero cancellation fees or penalties should you need to pause your investment premiums at any stage. But before making any changes to your existing RAs, be sure to determine whether you will be liable for any fees or penalties.
  • Your liquidity needs in retirement: There are inherent risks in housing all your capital in compulsory investment structures such as pension funds and RAs, specifically when it comes to accessing capital after formal retirement. As such, it is important to carefully assess any potential capital outflows in retirement such as the costs of overseas travel, home renovations or vehicle upgrades, as well as your emergency funding requirements. Before committing all your investment premiums towards compulsory funds, be sure you have carefully assessed your cash flow needs in retirement.
  • Estate planning considerations: Another risk of housing all your capital in approved retirement funds is the impact on your estate plan. Remember, the funds invested in your RAs do not form part of your deceased estate and, in the event of your death, will be distributed in terms of Section 37C of the Pension Funds Act to those who are deemed to be financially dependent on you (in whole or in part) at the time of your death. On the other hand, money held in a discretionary investment will be distributed as per your wishes. As such, it is important to take your broader estate plan into account before taking out an additional RA.
  • Investment flexibility: It is important to keep in mind that any funds invested in an approved retirement fund (such as your pension fund and retirement annuities) are subject to the limitations set out in Regulation 28 of the Pension Funds Act, which places certain limits on your investment’s exposure to riskier assets such as equities and offshore assets. On the other hand, should you invest towards a discretionary investment such as a LISP (unit-trust-type investments offered by ‘linked investment service providers’), you have full investment flexibility and can construct a portfolio entirely aligned with the investment returns you require. So, before taking out another RA, it is important to understand what investment returns you will need to achieve to reach your retirement goals.
  • Your income needs in retirement: There are benefits to having multiple RAs in place, although the decision to have multiple RAs should be a strategic one. Remember, when retiring from an RA, you are required to use at least two-thirds of the investment to purchase an annuity income either in the form of a life annuity or a living annuity. If you set up a living annuity, you can only adjust your drawdown rate each year on the policy’s anniversary, which can be somewhat restrictive. The benefit of having multiple RAs in place is that you can stagger your respective retirement dates which, in turn, will give you the equivalent number of opportunities in a tax year to adjust your drawdowns – thereby providing you with some income flexibility in your retirement years.
  • The status of your existing retirement annuities: As pointed out above, there are benefits to having multiple RAs in place although it is not always necessary.

Instead of setting up a third RA, keep in mind that you have the option of increasing your investment contributions towards your existing RAs to the most tax-efficient level.

That said, it is important to establish whether either of these RAs enjoys what is referred to as a ‘grandfathered’ status, which effectively means that it is exempt from complying with the provisions of Regulation 28.

Those retirement annuities that were taken out before 1 April 2011 (when Regulation 28 became effective) are not required to comply with these restrictions. However, if material change – such as a contribution increase – is made, the investment will need to comply with Regulation 28. As such, before making any material changes to your existing RAs, be sure to understand their existing status.

As is evident from the above, while reducing one’s tax liability is an important consideration, there are multiple other factors involved when structuring one’s retirement funding portfolio, and our advice is to seek the guidance of an independent financial advisor.

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