Retirement trade off: RA, TFSA, and a personal account

[elly1]

I’m crunching some numbers on my retirement savings and I’m looking for anyone to point out flaws in my logic or subtleties I may be missing. In terms of my retirement savings, I believe I have 3 options of putting money away.

Retirement vehicles​

1. Retirement products (pension fund/retirement annuity): The traditional savings vehicle with a max deductible of 27.5%. The funds will be placed in a balanced fund. Tax is payable on the lump sum received upon retirement.
2. TFSA: Max contribution of R36 000. The funds go to a an equity ETF tracking MSCI ACWI. No tax. Deposited after tax.
3. Personal account: A personal brokerage account where the funds are invested in an ETF tracking MSCI ACWI. Deposited after tax, and capital gains tax incurred at retirement withdrawal.

Some Notes​

• The reason for the slant on tracking a dollar denominated index (ACWI) is that I will likely emigrate and thus it’s in my interest to have my savings reflect dollar exposure.
• For tax purposes, let’s assume I am fortunate to retire with a decent chunk and hence both CGT and the lump sum tax will be at the highest possible rates.
• Thus, the tax bill will be 18% (max marginal CGT) of the gains on my personal account and 36% of my lump sum amount. That is, the % tax for CGT will be less than the % tax for the PF/RA lump sum?
• I have 35 years to retirement
• I am assuming there is a risk premium attached to the ETF investments above the balance fund of 2% (i.e. the ETF will fetch 2% more p.a. compared to balance fund).

Retirement product vs personal savings​

Given the return premium on a personal investment above a PF/RA (equity ETF vs balanced fund) and the relatively lower tax rate (18% CGT vs 36% of lump sum), saving for retirement in a personal brokerage account becomes quite attractive for my 35 years horizon. Obviously, putting all my retirement savings in a brokerage account has downsides:
- No forced financial restraint (I can withdraw the money whenever).
- It is not tax deductible, hence I will have larger PAYE.
- All my money will be in equities, but my argument is if a world equity index underperforms a balanced fund over 35 years then something very weird has happened in the financial system.

In my view, I can get more bang for my buck by investing via a brokerage account than putting it into a PF/RA (due to higher annual return and less tax). However, it’s subject to the above downsides. Am I correct in assuming that the optimal retirement plan is a trade off in balancing the higher annualised returns of saving personally and its downsides with the advantages of a PF/RA with the downside of lower annualised return?

My retirement plan​

In the coming year I am in the fortunate position to save a reasonable amount of money (provided I’m prudent with my monthly expenses). I am planning to divide my retirement savings into PF/RA contribution (10% of gross), TFSA (4% of gross), and personal account (4.5% of gross). I have a decent chunk allocated to short/medium term savings.

I haven’t made any commitments based on the above, but I would like someone to point out flaws in my reasoning/understanding before I embark on my journey.

 

[wrightdjohn]

@elly1 There are a couple issues that I see:

Firstly, you need to remember that you cannot take the full amount of your RA at retirement. You are only allowed to take 1/3rd as a lump sum. The other 2/3rds need to buy a compulsory annuity (life or living annuity). The first 1/3rd you take as a lump sum, the first R550 000 you can take tax-free, only the balance above this do you pay tax according to lump sum withdrawal tax tables.

Secondly, things to consider with an RA. Contributing to an RA obviously allows you to get a tax benefit but it is also outside of your estate (which results in a 20-25% estate duty saving) and is also out of the reach of creditors (for example you are a high risk business owner).

Thirdly, with regard to the ETF, look into the same ETF but one that is a "Feeder Fund". (Often stated as MSCI ACWI FF) Feeder funds earn the same growth as the normal fund but has the added benefit of also gaining the growth due to rand depreciation. For example if the USD/ZAR is R20 now, and R30 in 20 years time, that 50% "growth" will be gained within that fund too on top of the normal growth. Which is super nice within a TFSA as you do not pay CGT on this extra growth you achieve on Rand weakness.

Lastly, I think you should also take fees into account. RAs in SA are quite expensive, usually in the range of 1.5-2% while if you open a TFSA or Unit Trust with an Easy Equities or Ninety One for example, you can get away with under 1% all in, I think this should factor into your calculations.

 

[elly1]

@wrightdjohn

• Thank you! I wasn’t clear but I’m aware of the 1/3 lump sum and the R550k tax free. In my assumptions I’m assuming my previous contributions will exhaust the R550k and subject me to the highest rate of tax (36%) on my RA.
• Ah yes, the estate and creditor protection are facts that I forgot about.
• Also wasn’t clear, but FF are my intent! Thanks.
• I haven’t considered RA fees in their entirety. Let’s say I have an inexpensive fund (Sygnia Skeleton 70) with fees of 0.42% p.a., what other fees are applicable?

Edit: with regards to the 2/3 of the RA being placed in a living annuity, what would the tax be like then? I assume I will be subjected to income tax based on the monthly pay out I receive?

 

[tillotw]

@elly1 Another thing to consider is the possibility of 'prescribed assets' - forcing your RA to be invested in ways that probably will reduce returns.

 

[elly1]

@tillotw Yes of course! Thats another motivation for me to have more control over my retirement savings.

 

[pragyana]

@elly1 What inflation and tax rate are you using for your retirement calculator?

 

[elly1]

@pragyana I’m assuming inflation averages 5%. For capital gains tax I’m assuming getting taxed at 18% of my gains (40% x 45%). For RA, I’m assuming contributions I made previously will exhaust the R550k tax free and I’ll get taxed at the highest rate (36%).

 

[pragyana]

@elly1 Depending on your standard of living, inflation is at least 19 to 12% pa, I have been retired for 9 years, and that's what I found.

 

[pragyana]

10 to12 %

 

[faith4l]

@elly1 I have done some comparisons in the past on this as well. There is so much that needs to be factored in that the results can be different based on the inputs and very different based on time frames. Ultimately, my recommendation, excluding estate benefits, lower income and bigger time horizons should not do RA. Bigger (say top 2-3) tax brackets that are within 10-20 years of retirement can/should switch to RA rather since the compounding of the taxable contributions will not have time to catch up to the contribution rate of the RA account (referring to newly invested money). Also, this depends on withdrawal amount during RA. Which frankly is extremely hard to predict 20-30 years out.

I have build a model that will basically do the comparison for you based on the expectations/inputs with current salary etc. Will get back to you

 

[faith4l]

RemindMe! 10 day

 

[tillotw]

@elly1 Your assumptions around various tax rates, allowances etc will almost definitely change over the time periods you are considering (e.g capital gains) so should be a general consideration. Your strategy will benefit from being able to change allocations.

 

[prarierose91]

@elly1 If you are serious about emigrating, don't bother with an RA. Use you 1m SDA and invest everything offshore directly. I say this because getting your money out of an RA when u emigrate is an almighty pain and fully taxable.

 

[warriorcatsbooklover]

@elly1 I saved this thread hoping for more engagement since I appreciate the homework that you've done OP.

I just was someone to say yes or no to the argument that RA's are not the best retirement vehicle but I guess it's not that simple.

 

[elly1]

@warriorcatsbooklover The only compelling reason I can see to hold an RA is the estate/creditor protection. For me, the tax argument is less compelling because given my long time to retirement my investment in equities will more than make up for the initial tax bill. The tax upon retirement will also be less when I pay CGT compared to the RA tax.

Fyi, I’ll be putting money into my PF to for a “base” for my retirement savings. But there are other considerations:
- To ensure financial discipline and not dipping into retirement savings, I will need a separate account at a different broker.
- Also wise to split your investment savings between different brokers. Don’t want all your eggs in one basket if a brokerage goes bust! It’s unlikely given good regulation in SA, but it’s still a risk.