Why a retirement annuity is designed to be “locked in” until 55

An introduction to investments in South Africa [video] - Rands and Sense by 10X

Want to know about offshore investing, property as an asset class, tax-free savings accounts and everything in between? Rands and Sense by 10X is here to help you understand investment fundamentals. Read more

As an investor, it can be frustrating to have your savings tied up in your retirement annuity and almost inaccessible until age 55. It is understandable that this may feel inflexible and difficult for you, especially when emergency savings are required. However, the rationale behind this rule is to keep your money invested so that it may potentially grow and compound over the long term. This capital will then eventually provide for the retirement years.

In this article, we will take a closer look at what happens at retirement age, the Two-Pot Retirement System, and the benefits of keeping your capital invested for your long-term retirement outcomes.

The purpose of a retirement annuity

Retirement annuities are long-term retirement savings investment vehicles designed to offer you, the investor, some great tax incentives. Contributions to retirement annuities are tax-deductible, subject to the specified annual limits, which are up to 27.5% of your income or R430,000. This can reduce your taxable income and improve the overall efficiency of your retirement savings strategy.

In addition, investment growth within the retirement annuity is also exempt from income tax, dividend tax and capital gains tax while invested, thereby allowing more returns to be reinvested and potentially benefiting from compound growth over time.

These tax advantages are designed to encourage long-term retirement savings. In return, retirement annuities are subject to rules that limit access to the money before retirement age. This can feel restrictive at times, but the goal is to preserve your savings for their intended purpose: providing you with income during retirement and greater financial stability in your later years.

A fixed deposit? No thanks!

Moneyweb regular Jimmy Moyaha discusses the problems with that old bank favourite, a fixed deposit, and what else you can do with your money. Read more

The Two-Pot Retirement System

The implementation of the Two-Pot Retirement System in September 2024 changed how contributions and withdrawals to and from retirement products are handled in South Africa. All contributions to retirement products, such as your retirement annuity, are now split between two pots, namely a ‘retirement pot’ and a ‘savings pot’. There is also the ‘vested pot’, which comprises all savings accumulated prior to September 2024 and remains governed by the old rules.

The bulk of your savings will go to the retirement pot, with one-third of contributions being allocated to the savings pot and the remaining two-thirds of contributions being allocated to the retirement pot.

Withdrawals from the savings pot are permitted once per year, for a minimum amount of R2,000. Withdrawals are taxed at your marginal tax rate, and there will also be an administration fee levied. Ideally, the savings pot should be accessed only in emergencies, preferably not at all. The retirement pot can only be accessed upon retirement, at age 55, and will then be used to purchase either a life or a living annuity.

Please consult the latest FSCA guidance for the most up-to-date information on the Two-Pot Retirement System.

Why the money is “locked in”

Some investors may find it frustrating that retirement annuity savings cannot generally be accessed before age 55, but the purpose of these rules is to encourage long-term retirement savings and protect investors from making short-term decisions that negatively impact retirement outcomes.

Preventing short-term decisions that hurt long-term outcomes

A retirement annuity is specifically designed to be a long-term investment vehicle rather than a source of short-term funding. By restricting access to retirement savings, the legislation aims to ensure that the capital is preserved for its intended goal, which is to provide you with an income during retirement.

Keeping the money invested for the long term harnesses the potential power of compound growth, leading to better long-term results for your savings. The longer your capital stays invested, the greater the chance for investment returns to generate further returns over time.

Let’s look at an example to illustrate the profound effect of compound growth:

Scenario 1: You decide to invest a R100,000 lump sum and generate 6% real return over 30 years.

Scenario 2: You decide to invest a R100,000 lump sum, and also include a debit order of R1,000 per month for 30 years, which also generates a 6% real return.

In Scenario 1: You end up with approximately R482,000.

In Scenario 2: You end up with approximately R1.5 million.

We can clearly see how keeping your savings invested can lead to potentially significant compound growth advantages.

The tax benefits associated with retirement annuities also support this long-term objective. Contributions to your retirement annuity will have the effect of reducing your taxable income, which is a great benefit. This means you pay less tax on the income you earn.

When viewed in this context, we can see that the age 55 restriction is not intended as a penalty but rather as a mechanism to protect investors and help them preserve their retirement savings.

What actually happens at age 55

From age 55, you can retire from your retirement annuity and access your savings, subject to the applicable retirement regulations. At this point, you will need to make key decisions regarding how your savings will be used to provide you with an income during retirement.

Under the existing rules, you can withdraw up to one-third of your retirement savings in cash, while the remaining two-thirds must be used to purchase an annuity (either a living annuity or a life annuity). If the total value of your retirement annuity is less than R247,500, you may withdraw the full amount in cash without purchasing an annuity.

If you decide to withdraw a lump sum cash amount, this will be taxed according to the retirement lump sum tax tables. These are the retirement lump sum tax tables as taken from the SARS website:

Your hard-earned savings that have accumulated in your retirement can now be converted into an annuity, which will be a source of income for you for your retirement years. Transferring more of your capital to an annuity, instead of withdrawing cash, may mean you have more money available to provide you with an income for retirement. If you have selected a living annuity, having more capital available to invest may potentially mean more money potentially growing and compounding over time.

How investment strategy matters when money is locked in

As your retirement annuity is meant to be a long-term investment, it’s generally advisable to include a percentage of growth assets, such as equities, in your portfolio. You would want to ensure that your percentage of growth assets is well-aligned with your investor profile, as well as with your long-term financial goals and plan. Your investor profile would look at both your risk profile and your investment timelines. Diversifying across different asset classes aims to balance risk and return, which can be a sensible approach to investing.

The asset classes that you would consider would include equities, real estate, bonds and cash. Asset allocation plays the biggest role in the performance of your retirement annuity, accounting for over 90% of returns, as seminal research from Brinson, Singer and Beebower shows. At 10X, investors can customise their underlying portfolio by choosing from a selection of carefully curated investment funds, each with a different mix of assets and geared towards different investor profiles.

As mentioned, equities are most likely to provide the best returns in the long term, albeit being the most volatile of the asset classes. As data suggests, equities have historically produced returns above inflation - by around 7% annually - over the long term (based on JSE All Share Index performance versus CPI from 1960-2020). Keep in mind that past performance doesn’t guarantee future results. Real estate may serve as a good hedge against inflation while providing strong returns. Bonds add stability to a portfolio, but may produce lower returns. This doesn’t mean bonds will never outperform expectations, merely that they’re seen as a more conservative option. Finally, cash is likely to offer the lowest returns while also being the most stable among asset classes.

You may also consider investing offshore, which can offer additional opportunities for the investor due to the larger international market. Of course, you will need to adhere to Regulation 28 of the Pension Funds Act. This act limits the percentage of your portfolio that you can invest in both equities and offshore: you can invest up to 75% in equities and 45% offshore.

Our 10X funds give you access to the various asset classes and also local and offshore exposure. This allows you to select a fund that meets your needs while focusing on long-term returns. Please explore our funds for the most up-to-date fund information.

Why fees matter even more in a retirement annuity

Fees may have an impact on your retirement annuity. This is especially evident when the fees are compounded over time; even a small difference in fees can have an impact on your final investment amount. Fees are something that you, as an investor, can have more control over, so careful attention should be given to these. Let’s look at an example to compare higher fees (3%) with lower fees (1%) to help illustrate the effect that fees may have on your retirement annuity’s final investment value.

• Investment period of 30 years
• Initial lump sum investment of R50,000
• Monthly contributions of R2,000
• Return of 12% per annum
• An inflation rate of 6%

Example 1 (1% Fees): Real investment value is approximately R1.8 million

Example 2 (3% Fees): Real investment value is approximately R1.3 million

A small difference in fees can impact your final investment value. Please note that this example is for illustrative purposes only, and real results may vary. You can find out more about how fees impact investment outcomes here. There are a few usual fees that you may see deducted from your retirement annuity. Let’s have a look at some of these fees:

• Advisor fees: An advisor will charge fees for the advice they provide. There may be both an initial and an ongoing fee charged.
• Administration fees: There will be administration fees charged for the admin-related tasks. These may be tasks such as reporting, compliance and more.
• Management fees: Fees charged for management of the fund.

The Effective Annual Cost (EAC) is a useful metric for you to use in order to determine the total fees and costs associated with owning a product over a one-year period of time. All else being equal, a higher EAC would mean that less of your investment returns can be reinvested and potentially grow and compound over time, while a lower EAC may mean that more of your returns may be reinvested and potentially grow over the long term. The EAC of an investment is just one factor to consider when comparing service providers. At 10X, we offer a useful EAC calculator. It is a part of our free online suite of tools and allows you to compare the EAC of your current provider with the EAC charged by 10X, allowing you to make any necessary changes. At 10X, we offer a low, transparent fee structure with no hidden costs. Please visit our website to see product-specific fees.

The bigger picture: Freedom later requires discipline now

Taking a disciplined and consistent approach to investing now can pay off when it comes to your retirement years, providing you with potentially more financial freedom. Ensuring you keep your capital invested until at least age 55 gives your money the opportunity to grow and compound over time, and allows you to harness the potential opportunities that come with long-term investing. Aiming to combine this with a strategic asset allocation and low fees can mean you are able to harness the growth.

The 10X Retirement Annuity focuses on low fees, transparency and keeping things simple. We aim for superior and consistent long-term returns for clients, helping to set them on the path to the retirement that they deserve.

Final thoughts on why retirement annuity savings are locked in until retirement

It can be frustrating to have your retirement annuity tied up until age 55, with access to your savings pot only once per year. But it’s important to bear in mind that this rule of having the money locked in until age 55 has been implemented in order to ensure that you, as an investor, are able to potentially maximise the retirement benefits and improve your retirement outcomes.

A retirement annuity is an excellent vehicle for saving for retirement due to the tax incentives on offer. This should be coupled with strategic asset allocation, low fees and a consistent and disciplined approach to investing.

At 10X, our excellent and skilled investment consultants are at your service to assist with your retirement annuity and any queries that you may have, setting you up for a comfortable retirement!