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.

Investing for the long run

A coming collapse in investment returns means that people that age today will have to work seven years longer or save almost twice as much to end up with the same nest egg as those of roughly a generation ago.

So says the research arm of McKinsey & Co. in a new report that argues that investors of all ages need to resign themselves to diminished gains.

The consulting company maintains that the last 30 years have been a “golden era” of exceptional inflation-adjusted returns thanks to a confluence of factors that won’t be repeated. They include falling inflation and interest rates, swelling corporate profits and an expanding price-earnings ratio in the stock market.

next two decades won’t be nearly as lucrative, even on the optimistic assumption that the world economy snaps out of its recent funk and resumes growing at a faster clip, according to the McKinsey Global Institute report titled “Diminishing Returns: Why Investors May Need to Lower Their Expectations.”

“We’ve had a wonderful 30-year period in terms of returns, way more than the 100-year average,” said Richard Dobbs, a McKinsey director in London. “That era is coming to an end.”

Bond investors have already reaped much of the benefits from declines in inflation and interest rates from the sky-high levels that prevailed in the 1970s.

Tougher Road

US and European corporations, meanwhile, will find it harder to boost profits in the face of stepped-up competition from emerging-market rivals and from smaller businesses able to tap into the global market through the Internet, Dobbs said.

It’s not only 30-year-olds and other individual investors who’ll be hurt if McKinsey is right about the outlook. Pension funds and university endowments also have reason to worry, Dobbs said.

The roughly $1 trillion funding gap confronting US state and local retirement plans could triple if McKinsey’s more pessimistic projections pan out, he said. US college endowments could be out as much as $19 billion per year, he added.

Two Paths

McKinsey sets out two paths for the economy and financial markets over the next 20 years in its report. In the slow-growth scenario, US gross domestic product expands by an average 1.9% per year, while growth in other major economies is 2.1%. Returns in that case are well below the average of the 1985 to 2014 period.

In the recovery scenario, US growth matches the 2.9% average of the last 30 years while non-US GDP rises 3.4%. Returns still fall short of the golden era when inflation and interest rates were falling and profit margins were expanding.

Whats wronf with Standard Bank in Japan

Three hours, around 100 people, 1 400 Japanese ATMs and 1 600 counterfeit credit cards, was all it took for fraudsters to exploit Standard Bank in Japan.

The bank, which stands to lose up to R300 million, described the attack as a “sophisticated, coordinated fraud incident” and said “swift action to contain the matter” had been taken.

“It is evident that it is an incident of transnational organised crime that was well planned and executed,” said Kalyani Pillay, CEO of the South African Banking Risk Information Centre (SABRIC).

Security experts agree, saying perpetrators went to “considerable trouble” to pull it off.

The gang is believed to have targeted Japan due to bank security measures, which permit the use of credit and debit cards with magnetic strips as opposed to the newer and more secure chip and pin technology, said Frans Lategan an IT Security Consultant at SensePost, which exposes vulnerabilities and weaknesses in computer-based systems.

According to The Yomiuri Shimbun, Japanese police believe the cash was withdrawn outside South Africa, the country in which the cards were issued, in order to delay the scam’s detection. That the withdrawals took place between 5am and 8am on Sunday, 15 May, is believed to be another delaying tactic. Seven Bank ATMs, located in 7-Eleven convenience stores, were also targeted as they are of only two Japanese banks that allow withdrawals on foreign-issued credit and debit cards. Each of the 14 000 transactions saw the gang withdraw ¥100 000 or roughly R14 300, the maximum withdrawal limit set for ATMs. However, transacting below a floor limit, could have also delayed detection as these transactions can be processed without bank authorisation, Lategan said.

The news site reported Japanese police are attempting to identify suspects by analysing security camera footage. Japanese and South African authorities are also said to be working together, via Interpol, to determine how the gang obtained the credit card data.

“In order for external parties to gain access [to credit card information], there usually involves some sort of collusion,” said Steven Powell, co-head of forensics at ENSafrica. He added Standard Bank would have to investigate whether its security measures were compromised internally or externally as well as whether the security breach was isolated to Japan.

“Unless we know what security measures were in place, it is hard to know what method was used,” said Lategan. He said the gang could have obtained the data from an inside source, merchant or other third party records or by exploiting numeration vulnerabilities.

When yo are saving for the short term

In this advice column Kyle Wakelin from PSG Wealth answers a question from a reader who wants to know how to invest a lump sum that may be needed on short notice.

Q: My husband has been working in the UAE for the past six years. However recently a number of expats were sent home without notice and he is worried that he may be next in line. He sent R320 000 across to South Africa so that we would have money here in the case that he did have to relocate and there was a delay in having his final salary paid out.

We want to know how we should invest this money so that it is available within 30 days if we should need it.

He also has a small pension with Old Mutual, worth around R110 000, and earlier this year he also invested R120 000 with FNB in case of emergencies.

I am unfortunately not able to assess your specific needs based on the limited information we have available. However, I will make a few assumptions to provide some focused advice which should, at least, steer you in the right direction.

Investors clearly need to differentiate between their short-, medium- and long-term requirements and invest in suitable investment vehicles. This means that short-term capital should be allocated to secure and accessible investments, while medium- and especially long-term capital can be invested in the type of investments that should generate inflation beating returns.

It is clear that the amount you wish to invest now may be called upon in the short term and for that reason it needs to be held in a conservative and accessible investment. I would recommend doing a budget exercise to determine what your actual expenses would be in the event of your husband being sent home on short notice. This figure should be a multiple of a chosen number of months – in other words work out six to nine months of expenses.

For this money I would recommend cash funds, such as money market funds. The rates are currently quite attractive and capital can usually be withdrawn within 24 hours. The money you have with FNB money may even serve this function.

You may want to be less conservative with any additional amounts, especially because there is no clear indication that you may need it. In this case you may want to consider investing in an income fund, which is still deemed low risk. There is slight risk of volatility, but with the opportunity of outperforming cash investments by 1% to 2% a year over longer periods.

Anything from a tax free account at a bank

Last month Intellidex released research that showed that a total of R2.57 billion had been invested in tax-free savings accounts (TFSAs) in the first 12 months that they were available. A total of 262 493 accounts were opened over this period, showing that there has been fair uptake of these new products.

The study also noted that an estimated 21% of these accounts were opened by first time savers. The initiative has therefore had some success in encouraging South Africans to save.

While this was a positive picture, there was an area of concern. That is that 59% of all TFSAs were opened at banks and the majority of the investments were held in cash.

The problem with this is that it will take years for investors to see any advantage from a TFSA if they are only using it to make a bank deposit. This is because tax payers already receive an interest exemption every year.

Currently this exemption is R23 800 for anyone under the age of 65, and R34 500 for anyone 65 or older. Any tax payer would have to earn interest above that threshold to pay any tax on it.

The best rates currently available on bank deposits in TFSAs are around 9%. So for anyone under the age of 65 to earn more than R23 800 a year in interest and therefore benefit from a TFSA, they would need to have R265 000 in their account.

Since you can only invest R30 000 into a TFSA every year, it would take a minimum of around six and a half years to build up that amount, even accounting for compound interest. It is therefore fair to assume that most people who have opened TFSAs at banks are actually not seeing any benefit from them.