June 19, 2010
By Neesa Moodley-isaacs
There are various types of investments, but you need to think about what your goals are, why you are investing and what the different benefits are before you choose an investment vehicle. Gerrit Viljoen outlined the main types available to the person in the street: unit trusts, endowment policies, retirement annuities (RAs), preservation funds, provident and pension funds, and living annuities.
"When you buy a car, the type of car you buy will vary according to your needs at the time and the particular life stage you are at. For example, for your first car, as a single-income earner, you might look at a nippy, fast car. Later, when you are married with children, you are likely to prefer a family sedan. When your children have left the nest, you may decide to treat yourself to a convertible.
"Similarly, when you consider what type of investment to use, you need to consider the reason for your investment," Viljoen says.
For example, if you are saving for a medium-term goal and need to receive the proceeds of the investment in, say, five years, you would choose a unit trust instead of an RA.
On the other hand, if you want to save for your retirement and you know you are not disciplined enough to refrain from making withdrawals, you would choose a type of retirement fund.
UNIT TRUSTS
Unit trusts are a flexible investment vehicle, suited to medium- to long-term investments, because you have easy access to your funds.
# There are no minimum investment periods when you invest in a unit trust, and you can make unlimited withdrawals from a unit trust fund, at your discretion.
"Depending on the type of fund in which you invest, it is considered prudent to leave your money invested for about three to five years to recoup the investment costs and so you can earn a decent return," Gerrit Viljoen says.
# Unit trusts are governed by the Collective Investment Schemes Control Act.
# You can cede a unit trust completely or partially as security for a loan.
# You cannot nominate a beneficiary on a unit trust investment. In the event of your death, the investment will be paid into your estate.
# You pay tax on the interest you earn. "This can be tax effective because, depending on the type of fund, the interest earned may well fall below your tax exemption on interest," Viljoen says.
The tax you pay on your returns will depend on the applicable exemptions and on your marginal tax rate. The exemption on interest income for the 2010/11 tax year is R22 300 if you are under 65 years old and R32 000 if you are 65 or older.
Any increase in the value of the units is taxed as a capital gain when you dispose of or sell the unit trust. The capital gains tax exemption for the 2010/11 tax year is R17 500.
LIVING ANNUITIES
Living annuities, not to be confused with retirement annuities (RAs - see "Retirement funds", below), are used as a post-retirement investment vehicle, and you would typically transfer funds from an RA, pension, provident or preservation fund to a living annuity. These investments are regulated by the Financial Services Board and the Long Term Insurance Act.
# Living annuities are an alternative to traditional annuities. With a traditional annuity, a life assurer guarantees you a fixed pension for life. With a living annuity the risk of your capital being sufficient to provide you with an income for life lies with you, because you must choose the underlying investment.
# As with retirement funds, you cannot cede a living annuity as security and it does not necessarily form part of your estate when you die. You can nominate a beneficiary.
# This type of investment has its limitations, Gerrit Viljoen says. You cannot make any further monthly contributions, you cannot access your funds in the form of a lump sum, and each year you must draw down income at a rate between 2.5 and 17.5 percent of your capital investment. You can only amend the percentage income you draw down once a year on the anniversary of the investment.
The income you draw down is subject to normal income tax rates.
It is important to carefully calculate your drawdown rate: if the income level you select is too high, your income may not be sustainable over the length of your retirement.
ENDOWMENT POLICIES
If you have trouble being a disciplined saver, you could consider a life assurance endowment (investment) policy, where you are obliged to save and preserve your savings for at least five years.
# These investments are governed by the Long Term Insurance Act.
# The minimum investment term is five years. If you commit to paying a monthly premium and then find you cannot meet the monthly payments, the life assurer can impose penalties.
# You can cede a policy outright as security for a loan or as collateral.
# You can and should nominate a beneficiary on an endowment policy. Gerrit Viljoen says that no executor's fees are payable on endowments if you nominate a beneficiary.
If you do not nominate a beneficiary, the money is paid into your estate where it does attract executor's fees. Executor's fees are paid to the executor of your estate and are a maximum of 3.5 percent plus VAT, which amounts to 3.99 percent of your gross estate, and six percent of any income collected after you die. You can negotiate executor's fees when you draw up your will.
# Estate duty is payable on the benefits of an endowment policy. The executor of your estate must calculate the net value of your estate after accounting for all the deductions and exemptions allowed by the South African Revenue Service. The first R3.5 million of the assets in your estate is exempt from estate duty. Estate duty is then calculated at a rate of 20 percent of the net value of your estate.
# Viljoen says endowment policies can be tax-effective if you fall into a high tax bracket. The reason is that the interest, net rental income and foreign dividends are taxed at a rate of 30 percent in the hands of the assurance company.
This works in your favour if you fall into higher marginal tax brackets above 30 percent and have used up your interest exemptions, he says.
The capital gains earned by an endowment fund are subject to capital gains tax (CGT), again in the hands of the life assurance company. No exclusions apply.
Because both income tax and CGT has been paid by the assurance company, you do not have to pay any further tax when you are paid out.
# You are allowed only one withdrawal and one loan during the first five years of the policy, after which you can make withdrawals.
In the first five years any withdrawal will be subject to early withdrawal penalties by the life assurer.
# Risk benefits, such as life and disability cover, can be added to the policy.
# You make either monthly contributions or invest a lump sum.
# The annual premium you pay can be increased, but not by more than 20 percent a year.
RETIREMENT FUNDS
If you are saving for your retirement, there are four different options available to you: retirement annuities (RAs), pension funds, provident funds and preservation funds.
# Retirement funds are regulated by the Financial Services Board and the Pension Funds Act.
# You cannot cede a retirement fund assets as security for a loan.
# Although you can nominate a beneficiary, the trustees of the fund have the final say in deciding who will benefit from the policy in the event of your death.
# If you invest in an RA or a preservation fund, you cannot withdraw your savings before the age of 55. For all other funds the date of retirement will be set by the rules of the fund. Previously the maximum retirement age from an RA was 70, but this age limit has been removed so that senior citizens over 70 can also enjoy the benefits of saving in RAs. In the case of a preservation fund, the retirement date is usually the same as that of the retirement fund from which you made the transfer.
# Retirement funds do not normally form part of your estate.
# Increasingly, you have to choose the underlying investment strategy for your retirement savings.
Tax
"Retirement funds are tax-effective investments, since you do not pay any tax on your investment during the build-up period to retirement," Viljoen says.
In the build-up you can deduct contributions up to pre-set limits from taxable income; and the returns are not subject to any tax. Contributions to provident funds are not tax deductible.
When you do retire, the benefits from your retirement fund are taxable, apart from a portion of the lump sum amount, which is tax-free.
The tax rates for lump sum retirement fund withdrawals are: the first R300 000 is tax-free; any amount between R300 001 and R600 000 is taxed at 18 percent; any amount between R600 001 and R900 000 at 27 percent; and any amount over R900 000 at 36 percent.
The tax benefit for lump sum withdrawals is cumulative and cannot be claimed more than once. This means that if, for example, you mature an RA at age 55, withdrawing a lump sum of R100 000, this will be deducted for tax purposes when you retire from an occupational fund at age 60. So you will then receive the first R200 000 of your lump sum tax-free.
The portion of your benefit that you use to buy an annuity is taxed at your marginal rate of tax, as and when you receive the monthly pension payments.
If you withdraw from an occupational retirement fund before retirement, the amount will be subject to tax if you take the cash.
Types of retirement funds
# Pension funds: The rules of the fund dictate your retirement date - this is normally between 60 and 65.
When you retire, you can withdraw up to a maximum of one third of your benefits as a lump sum. The remaining amount must be used to purchase an annuity (pension).
# Provident funds: When you retire you receive all your savings from the fund, with your contributions being added to the tax-free portion of the lump sum tax rates.
# RAs: These have typically been used by individuals whose companies do not offer them pension or provident fund benefits. However, RAs can also be used by people, who are members of occupational retirement funds, to boost their retirement savings.
You can transfer your RA between administrators. If it is a life assurance (underwritten) RA, penalties may be payable. If it is a unit trust-based RA, penalties are not normally applied. With a unit trust-based RA you also have the discretion to increase or decrease your contributions without limitations.
# Preservation funds: You can transfer your occupational retirement fund benefits to a preservation fund if, for example, you are retrenched or resign, thereby protecting the tax advantages.You cannot make additional contributions to a preservation fund. If you want to continue saving money for retirement, you will have to use another investment vehicle, such as an RA.
If you transfer your funds from a pension fund to a preservation pension fund, when you retire at least two thirds of the benefit must be used to purchase a guaranteed or a living annuity.
If you transfer your money from a provident fund to a preservation provident fund, you can withdraw all the funds available as a lump sum on retirement.
From Personal Finance published on June 19, 2010
