Not using RA more beneficial in saving for retirement?

[borga]

Many website and personal advisors will tell you that you should contribute to Retirement Annuity and how good your returns will be compared to saving after tax amounts but isn't it better to invest outside of an RA instead of contributing to a RA when you are young?

Benefits of an RA
Reduce your income tax by investing up to 15% of your non-pensionable income into an RA.
Investment growth is completely exempt from capital gains tax, dividend tax and income tax on interest.
Protected from creditors in case of bankruptcy.
Protected from you using it before retirement.

Disadvantages of an RA
Unable to access it until Retirement, so if you are not able to afford items such as food tough luck.
On Retirement you can only access 1 third of funds.
Lump sum taxed at rates ranging from 0% up to 36%.
The remainder goes into a RA which is tax per income tax tables.
Equities cannot be over 75%.

Benefit of investing outside RA.
Gains are taxed as capital gains so 13.32% (33.3%*40%) effective rate
Can utilise capital gain exception for portion of gains each year (currently R30,000).
More flexibility in investment options.

Disadvantages of investing outside RA.
No tax deduction on contributions.
Not limited to 15% of not pensionable income (I know RA is not limited but your tax deduction benefit is.)
Not protected from creditors.

While this might makes it seem like the RA is the better option, how much are your returns diminished by the requirements of reg 28 over the full span of your career?

If we look at these two article then the difference can be quite substantial.
http://www.moneyweb.co.za/moneyweb-unit-trusts/sas-top-reg-28-compliant-unit-trusts
http://www.moneyweb.co.za/moneyweb-unit-trusts/south-africas-unit-trust-heroes

The RA had an average return of 16.73% and TER of 1.92%, whereas those outside the RA had an average return of 24.61%, so a difference of 7.89% and
TER 0.34% for the past 5 years, 10 year RA is 16.34% (TER 1.5%), Non-RA 22.63% (TER 1.64%).

So choosing to invest outside of an RA you are immediately 40% worse off as you are only investing the after tax amount, however due to a higher return than you can get in the non reg 28 fund, the investment can close the gap and surpass the RA, then at retirement you have a tax free amount (already paid capital gains on it during investment life) whereas with the RA you have to pay tax on the lump sum a large portion could be at 36% if your RA is large, with the remainder being taxes as income (18-40%).

So wouldn't a more beneficial method of saving be to not use an RA to save when you are young (and not benefit from a 18-30% tax deduction) and invest in Non reg 28 funds, and just use the last say 20 years before retirement (when you have a higher tax rate, due to higher salary from experience) to invest in an RA, then the difference in returns will compound less and you would still be able to able to have part of your lump sum taxes at the 0% rate.

Other points to consider:
Your retirement saving is not protect in case of bankruptcy. However how many people with stable job that are fiscally responsible enough to avoid filing for bankruptcy during their life?

Situation A
You start contributing to a RA at 45.
Situation B
You start contributing to a RA at 25.

The difference in the above case if the contribution during year 45-65 is the same is that a RA from Situation B will pay out a lot more than a RA in situation A, this will result in your RA placing you in a higher tax bracket.

So to phrase it another way, during your 20s and 30s you contributed and got a tax saving of 18-30% only to later have to pay additional tax on in at a higher rate due to having more in the RA, that is in addition to the opportunity cost from being forced to invest in Reg 28 funds which seems to give a lot smaller return.

Can it be more beneficial for someone fiscally disciplined who would expect their salary to greatly increase during their career (e.g. CA, Lawyer, Doctor etc.) not to invest in a RA when you are young (and get better returns) and only invest in it close to retirement when you have a higher relative salary to still obtain most of the benefits from an RA or am I missing something important?

I tried to simulate it in excel and the non-RA option seems better when you still have decades from Retirement.

https://docs.google.com/spreadsheets/d/1ltAxlKCsNyWz-CQa1nNPc3Q4BXbLcMV1a7y5KvMGCCc/edit?usp=sharing

I admit that not using an RA may not be for everyone as it would require self decipline not to access your retirement funds because you "need" it now, also not taking on more debt that you can handle thus risking your retirement funds if you need to be sequestrate.

 

[BloodBurner9000]

Just two questions:
- what is non-pensionable income as opposed to "pensionable" income?
- to overcome the risk to creditors, can one not simply stash away your investments in an RA should sequestration be on the horizon? (dodgy off course)

I really appreciate your analysis and although I have my basic RA provision, I am aware of the risk of government changing laws during the next 40 years, hence not having everything in that basket.

 

[borga]

Just two questions:
- what is non-pensionable income as opposed to "pensionable" income?
- to overcome the risk to creditors, can one not simply stash away your investments in an RA should sequestration be on the horizon? (dodgy off course)

I really appreciate your analysis and although I have my basic RA provision, I am aware of the risk of government changing laws during the next 40 years, hence not having everything in that basket.

1.Pensionable income is the income used by your employer to calculate your pension or provident fund contribution. This income will typically include any fixed remuneration (e.g. salary or wages) but may exclude variable amounts such as commissions, bonuses and overtime.

Non-pensionable income is your taxable income excluding (if any) your pensionable income, retirement fund lump sum benefits, assessed losses and capital gains.

2. Your tax contribution would be limited to 15% of your non-pensionable income but you are allowed to be able to contribute more. I believe you can add your excess contribution to the tax free portion of any lump sump you received. However I am not sure what the legality of such actions would be, the courts may possibly in certain instances decide that due to the fact that you contributed to the RA to avoid paying some/all of your debts that you actions may be reversed, otherwise anyone could take out a loan, contribute it to an RA and file for sequestration and avoid paying back the loan. But I don't have much of a legal background not sure what the courts would do in such an event.

 

[supersunbird]

Disadvantages of an RA
1.Unable to access it until Retirement, so if you are not able to afford items such as food tough luck.
On Retirement you can only access 1 third of funds.
Lump sum taxed at rates ranging from 0% up to 36%.
The remainder goes into a RA which is tax per income tax tables.
2.Equities cannot be over 75%.

1. Its a disadvantage and an advantage, you cant cash out and invest in that friends "sure thing" restaurant or pub or buy some car you suddenly have an insatiable urge for (if you are 100% sure you have the disciple then its a maybe), and even if you are declared insolvent none (except SARS is think) can touch that money. You should have savings outside of the RA, maybe 15% into employers fund and 5% into a RA or whatever gives one 20% (at minimum 15%), then you must have savings and investments outside that too. (I know some of this was pointed out)

2. Is it really such a hindrance? You can have 75% equity and say another 15% in listed property funds, so that gives you 90% of higher risk. The rest (10%) in bonds funds.

 

[borga]

2. Is it really such a hindrance? You can have 75% equity and say another 15% in listed property funds, so that gives you 90% of higher risk. The rest (10%) in bonds funds.

Based on the two moneyweb articals I posted there is a 7.8% difference between the top 15 non reg 28 unit trust and top 15 reg 28 unit trust for the past 5 years, on the 10 year there is a 6.2% difference, a 6% difference in return will make a very large difference in terms of amount saved at retirement over the span of your career, so it could the difference between having a comfortable retirement and living from paycheck (payout in this case) to paycheck.

 

[Freaksta]

Based on the two moneyweb articals I posted there is a 7.8% difference between the top 15 non reg 28 unit trust and top 15 reg 28 unit trust for the past 5 years, on the 10 year there is a 6.2% difference, a 6% difference in return will make a very large difference in terms of amount saved at retirement over the span of your career, so it could the difference between having a comfortable retirement and living from paycheck (payout in this case) to paycheck.

Are you comparing averages? Or the best in each case?

 

[supersunbird]

Based on the two moneyweb articals I posted there is a 7.8% difference between the top 15 non reg 28 unit trust and top 15 reg 28 unit trust for the past 5 years, on the 10 year there is a 6.2% difference, a 6% difference in return will make a very large difference in terms of amount saved at retirement over the span of your career, so it could the difference between having a comfortable retirement and living from paycheck (payout in this case) to paycheck.

Yes, that's true. But what I'm saying is (if your RA is R2000 or more a month) you can self allocate in the RA:

75% Coronation Industrial Fund
15% some good Property fund
10% some good bond fund

But its difficult to know which fund will be the best and what the rand will do, so one cant look with just hindsight.

 

[brianj74]

What are your options for the RA vs other investment at retirement? Look into that... You don't just get the cash..

 

[^^vampire^^]

Surely it would be best to maximize the tax break on the RA (currently of 15%) and then put the rest into low, medium and high risk shares with a good spread?

Next year I'll be increasing my RA a little to maximise the rise to 27.5% tax break and the rest I have in UTs, ETFs and shares. This way i gain the best of both worlds. I can push the shares etc for great performance while getting decent return on my RAs.

The best way I see it is you draw the maximum each month at retirement to keep yourself in the lowest tax bracket which, if you saved correctly, will last you your entire lifetime easily and then use your shares and other investments capital gains to supplement the rest of your lifestyle.

 

[borga]

Are you comparing averages? Or the best in each case?

I was comparing the average for the top 15 funds as per those two articles.

 

[supersunbird]

One also has to figure in the tax free lumpsum. Say in 20 years time its R2 million, of your R15 million, that's 15% tax free.

 

[borga]

One also has to figure in the tax free lumpsum. Say in 20 years time its R2 million, of your R15 million, that's 15% tax free.

That is why I mentioned in my post that you can possibly choose to invest in your RA closer to retirement, someone in the middle of the 35% bracket (say around 450k) would be able to get a tax deductable around 68k, which would take about 22 years to get to 1.5mil at which point your 1/3 will fully utilised the tax free portion. If you are in a higher tax bracket you could get to that point sooner, I am aware that the above amount is in today's term however it is reasonable to assume that the money you have in your RA would grow in excess of the inflation yet the tax free threshold is would probably grow only at inflation, which means in nominal terms your one third would reach the tax free threshold sooner than the 22 years.

So someone in the higher tax brackets could start contribution to his RA only around 45ish and he would still have contributed enough to take full advantage of the tax free threshold yet also taken advantage of the higher returns outside an RA when he was younger.

 

[vash87]

As far as I know you can be invested up to 25% in listed property to it's still possible to have a 100% aggressive and regulation 28 compliant portfolio.

Also, bear in mind that any shares held more than 2 years are subject to CGT on withdrawal and no CGT applies to growth in RA's. Over a growth period of a couple decades, that's definitely an advantage for RA's. In my opinion the tax on retirement lump sums shouldn't be a big issue. Why not confirm your entire RA besides the tax free lump to a living annuity at the end of it's life to provide for your income needs. You can always have other investments for capital needs.

 

[vash87]

As far as I know you can be invested up to 25% in listed property so it's still possible to have a 100% aggressive and regulation 28 compliant portfolio.

Also, bear in mind that any shares held more than 2 years are subject to CGT on withdrawal and no CGT applies to growth in RA's. Over a growth period of a couple decades, that's definitely an advantage for RA's. In my opinion the tax on retirement lump sums shouldn't be a big issue. Why not confirm your entire RA besides the tax free lump to a living annuity at the end of it's life to provide for your income needs. You can always have other investments for capital needs.

 

[supersunbird]

As far as I know you can be invested up to 25% in listed property to it's still possible to have a 100% aggressive and regulation 28 compliant portfolio.

Many equity funds have property component (for example the Coronation Top 20s one hovers at around 4%). So yes, if you have a 75% fund you know for a fact doesn't, then yes, I guess one can probably go 25% property.

 

[Verde]

The RA had an average return of 16.73% and TER of 1.92%, whereas those outside the RA had an average return of 24.61%, so a difference of 7.89% and

Investing for retirement is not a maximisation game with one variable (return) as you seem to argue.
It is an optimisation game because there are many variables involved including return, risk, order of return risk, costs, tax, inflation, market correlations, life expectancy, ability to save, dependants, flexibility to postpone retirement or return to employment, employer/government funded retirement benefits, risk tolerance and many others.
The calculus involved is very complex.
I don't claim that reg. 28 gets it right, but focussing on return only is definitely not the way to go.

 

[borga]

Investing for retirement is not a maximisation game with one variable (return) as you seem to argue.
It is an optimisation game because there are many variables involved including return, risk, order of return risk, costs, tax, inflation, market correlations, life expectancy, ability to save, dependants, flexibility to postpone retirement or return to employment, employer/government funded retirement benefits, risk tolerance and many others.
The calculus involved is very complex.
I don't claim that reg. 28 gets it right, but focussing on return only is definitely not the way to go.

return, address in my first post
risk, you can avoid unsystematic risk by not investing in single shares instead choosing baskets such as EFT/unit trust, as for the remaining risk, equities is a higher risk investment but how high is that risk over the total investment period? http://powerstocks.co.za/jse_safe.php, your investment timeframe for retirement will in most cases be decades.
order of return risk, I assume you refer to Sequence of Returns (had to google what that meant), it seems to have more relevance when drawing on your funds, or how do you see it impacting while saving for retirement? you will also not be able to avoid this by choosing one method over the other. saving a constant amount each month would probably negate most of this effect over the long term as it would enable to buy before great returns which would offset buying before less great returns.
costs, Non-RA unit trust seems like it has a bit higher TER, however return after cost for the fund still seems higher for Non-RA, higher costs is not a bad thing if it results in higher returns.
tax, impact of tax has already been included in my evaluation for the non-RA investment, however for the RA I have not taked tax into account, doing so however will decrease the amount, futher increasing the advantage of a non-ra over a RA as shown by the calculation.
inflation, the cost of inflation will not be impacted by deciding to save for retirement via RA or not, it might place a higher emphasis on a higher return to ensure you don't lose purchasing power.
market correlations, not limiting your equity exposure might make you more vulnerable certain events however the investment term in this case is decades so you would be able to ride the ups and downs, shares tend to be one of the best performing asset classes over the long term. I might also add that the outperformance by non reg 28 funds I linked to in my original included one of the worst economic events yet still managed to exceed reg 28 funds by quite a margin.
life expectancy, not sure why you say life expectancy would be an variable in choosing how to saving for retirement as your aim in both choices your aim would be to maximise your funds at retirement and ensuring your drawdown is sustainable for your expected, non-reg 28 funds would also provide more flexibility to events in your life. Not choosing to use an RA doesn't exclude you from using your funds at retirement to buy annuities should you choose to
ability to save, Non-RA investments provide more flexibility, as with RA the tax benefit is 15% wheras non-ra you don't lose benefits by saving 30% one year and 0% next year.
dependants, It seems like Non-RA might be better in this case as it allows you more freedom in providing for your dependants prior to retirement, I am also not sure the exact rules should your death occur sooner than later however I don't think funds from a RA would be transferable to your dependents aside from your wife and underage children, so by choosing an RA you could contribute for decades yet only benefit for a few years and lose the rest.
flexibility to postpone retirement or return to employment, the ability to postpone retirement or return to employment should not be used as an excuse to reduce retirement investments for either option.
employer/government funded retirement benefits, This will impact your decision, however the most likely impact would be to decrease your non pensionable amount reducing the tax benefit for using an RA,
risk tolerance, risk tolerance and risk avoidance is important however it is important to also keep in mind the is also the risk that your current plan for retirement could result in a person having to vastly reduce their lifestyle in retirement. Short term risks may also differ substantially from long term risks. It is therefore important that risk be viewed in aggregated and over the full term you are exposed to the risk.

many others.

So even included the other variables you mentioned it seems like a non-RA investment could still be a better option under the conditions I mentioned (financially disciplined, not use RA for beginning of carreer only using it later with higher salary and still gain tax free benefits).

I am not saying that RA is bad or that people should not use it, just that it seems like under certain condition it seems like it could be more beneficial not to use it from the start of your career.

 

[Verde]

True - not all my points are relevant to the taxable vs tax advantaged debate. I was trying to make a broader point about retirement planning in a bull market world where no one seems to respect risk anymore.

The risk of being 100% invested in a diversified share portfolio is apparent if you look at someone who retired in the US in 1929 or in Japan in 1989.

Nobel prize winning economist Paul Samuelson won the risk v time debate in the 90's. He even wrote this brilliant single syllable explanation for the benefit of some of his slower critics.

http://ljsavage.wharton.upenn.edu/~steele/Courses/434/434Context/Kelly Resources/Samuelson1979.pdf

It is incredible that the financial services industry still perpetuates the myth that stock market risk reduces for longer holding periods. I am not aware of a single respected economist who still holds this view.

This paper by highly regarded academics caused a stir a few years ago, claiming that stocks are substantially more volatile over long horizons from an investor’s perspective.

http://dept.ku.edu/~empirics/Courses/Econ918/pastor-stambaugh.pdf

Here are some discussions on this matter on the Bogleheads forum:
http://www.bogleheads.org/forum/viewtopic.php?f=10&t=115941&hilit
http://www.bogleheads.org/forum/viewtopic.php?f=10&t=57903

 

[supersunbird]

But whether you are invested in a RA or outside you are screwed anyway if such a market event occurs.

 

[Verde]

Let me put it this way. Very few people have the ability, willingness and need to invest more than 60% of their retirement pot in equities, let alone the 75% allowed by reg. 28.