“I don’t need to start saving for retirement now. I’m young; I’ll start saving in a few years.”
This is quite a common statement and mentality for individuals in their 20’s and 30’s. However, the importance of saving for retirement cannot be reiterated enough. It’s vital to start saving as early as possible (ideally when you start earning a regular income.)
Okay, I want to start saving; what do I do next?
The next obstacle is understanding the different types of retirement savings products on the market. In this article, we’re going to give you a breakdown of three of the most-used products: a retirement annuity, pension fund and provident fund.
What is a retirement annuity?
A retirement annuity (RA) is a savings vehicle that is intended as a long-term savings solution. It offers numerous appealing benefits, including savings on taxable income.
Retirement annuities allow you to contribute a maximum of 27.5% of your total taxable income/remuneration (capped at R350 000 p.a.) and benefit from tax savings on the taxable income. Furthermore, investment growth, which can be dividends, interest, and capital gains, is tax-free.
When you retire, you can withdraw up to one-third of the total amount tax-free, unless the total investment value is below R247 500, in which case it can be taken as a cash lump sum. At this point in time, the first R500 000 of a lump sum withdrawal is tax-free (provided you have not made a withdrawal from another retirement fund previously.) The balance of the fund value needs to be used to purchase an annuity at that time, which will provide you with a regular income such as a life annuity.
A retirement annuity allows you to choose the underlying assets, but there are specific limitations: regulation 28 of the Pension Funds Act. Regulation 28 limits investment into particular asset classes and aims to prevent investors from taking too much risk with their retirement savings.
It’s also important to structure the allocation of your investment according to your age and risk profile. If you invest too conservatively at a young age, it can be just as detrimental to your future as investing too aggressively closer to retirement. A risk balance needs to be established.
Benefits of a retirement annuity
- Your contributions are tax-deductible.
- You can invest a minimum of R200 per month.
- An RA complies with the prescribed legal investment limits. These limits control the amount of exposure to specific asset classes, as mentioned above.
- You can’t access RA funds until you’re 55 years of age or older. Except in unique circumstances such as permanent disability and can no longer perform your job or upon full emigration. The longer the investment period, the more you can reap the rewards of compound interest. This means you have the assurance your money will continue to grow over time.
- If you have an RA from a linked investment service provider (LISP) you can decide how much to invest, and you can stop your contributions if you hit a tough financial period and can restart investing when the time is right.
- There are no fees or penalties on LISP platforms
What is a pension fund?
You’re only able to join a pension fund through the company with whom you’re employed. Your contributions and those of your employer are tax-deductible up to a particular point. When you retire, you have the option of taking one-third of the total amount in a cash lump sum, which will be taxed. The remaining two-thirds need to be used to buy an annuity, e.g. a life annuity – this will also be taxed.
Should you leave the company before you retire, you can transfer the funds out of the business’s fund into your new employer’s pension fund or a preservation fund. Alternatively, you can take a cash pay-out, but this amount will be taxed. What is a provident fund?
As mentioned above, before 1 March 2021, the difference between a pension and a provident fund was that when you resigned or retired, you were able to take the cash as a single lump sum, on which you’d be taxed, and you wouldn’t need to purchase an annuity.
The new legislation introduced from 1 March 2021 states that provident funds are now more like pension funds, and the following activities are now mandatory:
- Fund members are required to take a third of the benefit as a lump sum.
- They need to use the remaining two-thirds of the funds to buy a pension that provides them with a monthly income.
The other primary difference between a pension and a provident fund is the way tax contributions are handled. We’ll explain this in more depth in an upcoming article.
How Does a Pension or Provident Fund Work?
Salary contributions from employees and employers are put into a fund. The money in the fund gains interest when the insurance company invests the contributions. Money is able to go out of the fund to pay for benefits as well as for the expense of running the fund. According to the Labour Guide, “the money belongs to the fund and not to the people who contribute.”
We know we’ve thrown a lot of information at you, but the bottom line is that these savings products are aimed at helping you retire with peace of mind that you’ll be financially comfortable. For more information, speak to a business consultancy that has access to independent financial advisers who can explain the ins and outs of the various products and help you make an informed decision about which one suits your needs best.