Should I Top-up my RA or invest offshore?

Should I Top-up my RA or invest offshore?

This was the question posed most to us during the month of February. It is because investors have lost confidence in the local markets after years of poor performance and the restrictive exposure rules surrounding Retirement Annuities (RAs). The below graph indicates the performance of a random basket of SA Balanced funds compared to a basket of random Offshore equity feeder funds over a 5 year period:

As financial advisors, we cannot allow our general/opinion OR the politics of our country to determine the answer to this very important question posed by investors. As a result, we did the research and crunched the numbers. Below a short summary listing the main considerations between RAs and Offshore discretionary investing:

As a reminder, the main benefit of an RA is that contributions are before tax and investors are therefore allowed to contribute 27.5% of their gross annual income with a limit of R350k per annum (pa). Another important benefit of an RA is the fact that there is no capital gains tax on growth, or tax on dividends and interest.

In order to find a result to this question, we created an experiment where we assumed an investor that is affected by the 45% tax bracket. We presented two investment scenarios to this investor to either contribute annually R350k (before tax) towards an RA or R192,500 (R350k after 45% tax) towards an offshore discretionary investment. We assumed in both scenarios the contributions were made annually for 10 years.

The contributions were then future valued using the average returns over 5 years for both a basket of random SA Balanced funds and Offshore equity feeder funds as indicated in the graph above:

The results were profound! Like many readers, we thought that offshore discretionary investment would outperform RA investment by miles but due to the benefit of contributing larger amounts towards the RA before tax, the compound effect of a larger contribution outperformed the offshore discretionary investment by over 46%.

In a desperate attempt to demonstrate offshore investing is better, we took the experiment further, so that the investors start drawing an income off their savings and start paying income tax on the withdrawals. The hope was that since the income from the RA will be taxed according to the normal individual tax rates, it would be higher than the Capital Gains Tax (CGT) for the offshore discretionary investment, which works on an inclusion rate of 40%.

Not even the beneficial tax rules applicable to CGT and the fact that the investor paid zero taxes could help, and the RA annual income after tax was still 29% more than the offshore discretionary investment. In fact, the RA would have performed even better if we applied the one-third two-third rules. As a reminder, these rules state that that the investor must use two-thirds of their retirement savings to buy an annuity. The remaining one-third can be withdrawn in cash. The first R500k of the retirement cash lump sums (in aggregate) is not taxed.

At this point it is worth mentioning a couple of important observations about investment vehicles:

  • The limited offshore exposure dilemma associated with the RA scenario can be reduced by utilising a Personal Share Portfolio (PSP) where the underlying shares are all the JSE blue chip shares which happen to be listed in SA only. Speak to Vista Wealth Management to find out more about this solution
  • The offshore investor could have made use of an Endowment which is an investment structure that offers tax benefits to investors with marginal tax rates of more than 30%. This is because the life assurer pays tax on behalf of the investor and the proceeds are tax-free in the investor’s hands. For individuals, life assures pay tax at 30% on all income in the policy. This means an individual’s effective CGT rate in an endowment is 12% as opposed to 18% for high income earners affected by the 45% tax bracket in SA

Lastly, the above experiment excludes many risk factors which are difficult to measure and therefore take into consideration. These factors can very easily present the RA investor with massive hurdles without a way out viz:

  • RAs forced to invest in government projects and State-Owned Entities (SOEs) through prescribed assets.
  • SA growth reduces even more as a result of continuous mismanagement and looting of state resources
  • The ZAR weakens drastically as a result of continuous downgrades by rating agencies and reductions in foreign direct investments

Therefore, at Vista Wealth Management we advise our investors to diversify their retirement savings across both their pension allowance and offshore allowance. Always start contributing towards pension and then move over to your offshore exposure portfolio.

In conclusion, Albert Einstein was correct when he said that the eighth wonder of the world is compounded interest. As seen by result from the growth, the fact that a larger amount is contributed to your RAs has a massive benefit and should not be underestimated. We can only hope that law makers will, in future, increase the offshore exposure allowed by Regulation 28 of the pension fund act. This will make contributing to your pension savings a no brainer and research like this unnecessary.

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