Many people will consider to invest in retirement annuities (RAs) before the end of February 2014, which represents the close of the country's tax year, in order to take advantage of the tax break. However, investors often negate this benefit by paying high investment fees.
Steven Nathan, CEO of 10X Investments
This is according to Steven Nathan, CEO of 10X Investments, who says their research shows that the tax benefit is equal to approximately a 1% fee saving, so if you pay 1% more in fees then you offset the tax benefit. "Therefore, investors only benefit from the tax break if they pay low fees."
Most investors do not do enough homework when investing and often end up with funds that are not optimal for their investment goals. "Pitfalls include poor fund selection, under-performing fund managers and high fees. These mistakes can potentially halve your final pension."
Five principles
Nathan advises investors apply five common sense principles to all long-term investments, including RAs, to ensure a better return on investment:
- Own well diversified portfolios - do not put all your eggs in one basket. Your portfolio should own listed shares, listed property, bonds and cash and include 25% of international investments.
- Time drives investment risk. People should own portfolios based upon their time horizon. The longer your time horizon, the higher your portfolio's weighting in equity (shares), up to the maximum 75% limit. You should reduce the equity weighting as you approach retirement if you intend to purchase a pension for your retirement. If you intend to remain invested in a living annuity at retirement, then you still have a long-time horizon and a high equity portfolio may still be appropriate.
- Index funds (tracking the market return) provide superior returns (adjusted for risk and costs) versus active funds. Invest in low cost index funds rather than expensive active funds.
- Fees must be minimised to maximise the investor's long-term returns. Don't pay total fees of more than 1.5% of your investment balance and preferably lower. Note that each 1% in fees saved increases your final pension by approximately 30% over a working life.
- Stay the course - don't be swayed by short-term investment returns that are volatile, unpredictable and irrelevant to long-term investors. Focus on maximising the size of your RA at retirement, not next week or next year.
Tax free deductions
Nathan says many high earners invest in RAs to maximise their tax-free deductions. "However, from March 2015 the tax free deduction (currently uncapped at 15% of your non-pensionable salary) will be capped at the lower of 27.5% of your total taxable income or R350,000. These people have only two years to benefit from uncapped tax free contributions."
While RA season encourages people to save to benefit from tax advantages, people need to get into the habit of saving consistently and as early as possible rather than waiting for RA season, says Nathan. "Once you have a sensible portfolio using the principles described above then you need the discipline to save a meaningful amount each month. We believe you should be saving 15% of your total earnings towards your retirement. If you save early, time is your friend, as your investment benefits from compounding returns, but the opposite is also true."
