Why Retirement Annuities (RAs) should still play a key part in your investment portfolio

Lately I’ve seen numerous articles, had discussions with clients and came across various tweet storms where the humble RA has been slaughtered. The main arguments against them are : high fees, poor investment performance, inflexibility and regulatory restrictions.

I wanted to do an in-depth analysis of the value of the RA in a bigger investment portfolio, but it would be a futile exercise. There are just too many variables that could be easily manipulated to show a good or a bad scenario. Instead I’m going to focus on the bigger picture and the “why” at the end.

Before I start I need to put following into context. Unfortunately to this day, the vast majority of RAs are built on a legacy financial structure, with a legacy financial provider. This was an inefficient way of doing things and this led to a very high fee structure. Excessively high fees are unacceptable and by just looking at the EAC of the investment you will immediately be able to see where you stand. Your total EAC should be around 2% or less. Anything more is an indication that it is time to move those assets via a section 14 transfer to a more efficient provider.

The next important area is the performance of the funds you are invested into. You cannot achieve extraordinary returns will minimal volatility. Low risk funds = low returns. High risk funds = a chance of higher returns. Don’t confuse the two. But if your mandate is a higher allocation to risky assets then you would expect a higher return over the long term. Hence the performance may struggle over a year but over a 5 year period there should be superior returns.

There has been a big uptake in passive investing lately. Your return will then more closely be to what the market returns. If we factor into consideration that all investment managers have good and bad days, over the very long term going into a passive solution (index) is by far the smarter choice. Remember it comes at a fraction of the fee of an active solution.

Personally, I invest in the Sygnia Retirement Annuity fund and utilize the Sygnia Skeleton Balanced 70 fund. My internal rate of return (my actual return) for years have been floating around 12% and my total cost is 0.4% (which is already deducted from the 12%).

There is no reason why you can’t achieve a ~10% per year compound return on your RA. This now brings me to the actual reason why I still love RAs… the tax! The return above quoted is after tax because there is no tax in the fund. Plus your contributions to a max of R350,000 per annum is fully tax deductible. So you are able to put money into an investment and immediately receive a guaranteed return, pay no tax on your proceeds, have it locked away so you don’t make foolish decisions. This is not restrictive, but rather sound financial planning.

Yes, we know that tax will be due again later when you withdraw but by deferring your tax liability till when you have funds to pay it makes sense. In the interim if you generate 10% per year over a 40 year period you will have more than enough money to settle any amount of tax.

The tax refund that you get annually for SARS can also be used to fund other investments or your lifestyle. I’m happy to fight anyone on why an RA should form part of your portfolio – note however that there are various other assets that you should also include in your bigger portfolio. Happy to hear your feedback!