Contribute to an RA in retirement

In this advice column Mikayla Collins from NFB Private Wealth answers a question from a reader who wants to know what the benefits would be of investing a lump sum into a retirement annuity at retirement.

Q: I am of retirement age, have worked for myself my entire life and never contributed to any retirement scheme. I have a lump sum to invest, which is my accumulated savings on which I now plan to retire.

I have been advised to invest this money into a retirement annuity, but I am unsure if this is the best approach. Why should anyone invest money that was not previously tied to a pension fund into a vehicle that will tie up the capital forever? I could invest it elsewhere to generate the same returns and have access to the capital at any time.

Are there tax or fee implications that would make putting the money into an RA a better deal, or is my adviser the one trying to get the good deal?

Contributing a lump sum of voluntary money to a retirement annuity has various advantages and disadvantages. Some apply to the retirement annuity itself, and some apply to the vehicle you choose for producing your income in retirement. For the purposes of your question, I have assumed this to be a living annuity.

First of all, the lump sum you contribute to a retirement annuity will be allowed as a deduction against your income. This is up to a limit of 27.5% of your remuneration or taxable income, or R350 000 (whichever is lower) in the current year. So initially, you will get a tax deduction.

The amount that exceeds this limit would however be carried forward and can be deducted against your income in subsequent years, or will be deducted against your annuity income that you receive from your living annuity at a later stage. So although you only get an immediate tax deduction up to the limit, you don’t lose the full 27.5% allowance.

In addition, within the retirement annuity, and later in a living annuity, you will not pay tax on interest, dividends or capital gains.

However, within a retirement annuity there are restrictions as to how you may invest. These place limits on the amount you may have in equity (no more than 75%), property (no more than 25%) and offshore assets (no more than 25%). As you are close to retirement, it is unlikely that you would want to take on the risk of exceeding these limits anyway, but it is something to take into consideration. When you retire and move the funds to a living annuity, these regulations will not apply.

In addition to this, as you have mentioned, your funds would be tied up to a certain extent. You can only take one third out at retirement and the remaining amount must provide you with an income thereafter. Assuming you invest the remainder into a living annuity, you will only be allowed to withdraw between 2.5% and 17.5% per annum of the value, and this amount can only be reviewed once a year.

It is best to explain how this all works by way of an example. Let us assume that your accumulated savings are R5 million and your current year’s taxable income is R500 000. Let us also assume that you intend to work for two more years and retire thereafter, and that your taxable income remains constant for the next two years.