The answer to this question is more complex than you might think. There are two main considerations that you will have to take into account before making a final decision, and they are:
- Will an investment into a retirement annuity provide me with a better return than a discretionary investment over the longer term?
- Does my personality align with the traits needed to successfully pursue an investment in a retirement annuity (RA)?
To answer the first question, the answer is most probably NO. If we do the calculations using assumptions that should be reasonable based on averages, the tax advantage of investing in an RA will benefit you financially for the first fifteen years, but after that the potential better returns on the discretionary investment will overtake the performance of the RA and by the time you turn 65, this difference will be substantial. The tax advantage we speak of is of course the 27.5% of taxable income that you may contribute to an RA and which will then be deductible for tax purposes up to a maximum of R350 000 per year. The disadvantage of investing in an RA is of course the fact that you have to invest at least 25% into non-equity assets such as bonds or cash, which generates lower returns than equities over longer periods of time, and of the 75% you are allowed to invest in equities, only 45% may be taken offshore. If we look at the 20-year average returns on an investment that will be suitable for an RA, we see a return of 10.54% per annum. If we assume that you invest your discretionary money in the S&P500, the 20-year annual return has been 15.10%. So your annual outperformance on the discretionary investment was 4.46%.
To answer question number 2 we have to consider the following factors:
- To take full advantage of the tax deduction you receive from investing in an RA, you have to invest the tax saving, and not spend it. Do you have the discipline to do that?
- Only one-third of contributions to an RA may be accessed before you turn 55, the balance must be used to purchase an annuity when you turn 55 or after that. Are you okay with the fact that you have no access to two-thirds of your money until you turn 55?
- The rule of law still counts in South Africa, but things may change. Are you okay with the fact that legislation may change the rules governing your RA without your having any say in the matter?
If we turn our attention towards investing in discretionary investments, there are also things to consider:
- You have full access to your funds. If you do not have the discipline to leave it until retirement, then rather invest in an RA.
- The past twenty years have proven that your returns were better investing in the USA, taking into consideration the depreciation of the rand against the dollar, but this might not be the same going forward.
- If you do decide to invest your discretionary funds earmarked for the longer term 100% into equities, make sure you can stomach the volatility.
Conclusion:
It might seem that, given the fact that your returns over the last twenty years were better if you invested 100% in US equities; and the fact that the political climate in South Africa will always be uncertain; an investment in a discretionary investment is better than an investment in an RA, but we would urge you to be very careful before just following the returns and not also considering your personal circumstances. There are other investment alternatives to get some tax benefits besides an RA, like the Tax-Free investment vehicle, where you can invest R36 000 per annum up to R500 000 over your lifetime and earn tax-free returns on it. The timing of starting an investment in an RA will also differ from person to person. Some investors might be better of investing in an RA from an early age to learn the discipline of regular investment, and others might be better of starting later in life and reaping the benefits of achieving better returns on an offshore investment early on in their investment journey. At the end of the day it will probably be best to invest in a mix of the options on the table and manage the flow of funds to the different options as your life cycle evolves.
