Question:
I'm 22 years old and do not belong to a work place retirement fund. Would the second best way to save for retirement be to take out a low-cost (10X) retirement annuity, or to just take out a run of the mill investment that yields a higher return than the industry average for a retirement annuity - or would the retirement annuity tax benefits outweigh this higher growth margin? Does 10X bundle all their retirement annuity clients' funds together to obtain higher growth? Your expertise will be very much appreciated.
Answer:
Lara,
Your question touches on many issues (and also suggests some misconceptions), so this is just a brief summary reply.
A retirement annuity is a merely a legal wrapper around your investments - it does not determine the investment return. The investment return depends almost entirely on your asset mix and the fees you pay. If you own the same assets in your run of the mill investment and pay the same fees as in your retirement annuity, then you would earn the same return. Invariably, you will own the same assets, whether you invest in a unit trust or a retirement annuity, namely SA shares, SA bonds, SA property shares, perhaps some international equity and some local cash. The mix of these assets is critical to your long-term savings outcome and should be appropriate for your age.
The retirement annuity wrapper confers tax benefits - tax-free contributions, investment returns and lump sums at retirement. But it also imposes restrictions (or discipline, to put a positive spin on it): regular monthly contributions, limited access your money until you turn 55, and when you do, you have to use two-thirds to buy an annuity. These restrictions are ultimately to your benefit - they ensure that you do not pre-spend your retirement savings before retirement, or over spend thereafter.
So the retirement annuity comes at the cost of flexibility. If you buy unit trusts, or simply shares through a stock broker account, then you can withdraw this money at any time. But you are investing after-tax money, you pay tax on dividend and interest income while the money is invested, and capital gains tax when you sell your investments.
Assuming you pay the same fees and hold the same assets, the tax benefits attached to a retirement annuity will enhance your return by as much as 30% over a 40-year savings term. However, many retirement annuity providers charge high fees (2% pa or more) which MORE than offsets this tax benefit, so if you choose a retirement annuity you do need to go for a low cost retirement annuity.
The other big difference is that a retirement annuity is subject to Reg 28, which prescribes assets limits. Effectively, you can only hold 80% of your savings in equities within a retirement annuity. Equities tend to generate the highest returns over the long-term, and if you are only 22, then you need to think long-term. If you invest directly, you can put all your money into equities. This should deliver a better long-term savings outcome, albeit at higher risk (because you are not diversified across asset classes).
At 10X, all our retirement annuity clients are invested (bundled) into one retirement annuity fund, which has ten life-stage portfolios. These portfolios all hold the same asset classes, but in different proportions. The percentage held in equities gradually and automatically diminishes as you approach retirement (unless you opt out of this glide path).
Bundling does not improve the investment return (this is not at all like a savings account where a higher balance may qualify you for a higher
interest rate), but the bigger the fund gets, the lower the fund's trading expenses (as a % of assets), so there is a scale benefit that is passed
onto our investors.
