Retirement is all about planning ahead, and you should start investing for your retirement as soon as you start earning an income. It can be daunting – how do you know if you’re saving enough and which type of retirement investment is right for you?

Retirement annuities and pension funds are both excellent savings options that enable you to save enough money to provide you with an income when you retire. One of the biggest advantages of contributing towards retirement funds is that your contributions qualify for a tax deduction up to a limit of 27.5% of your taxable income (capped at R350,000 in a tax year).

Pension funds versus retirement annuities

Employers set up pension or provident funds for their employees. Each month, they deduct a portion of your salary as a contribution towards this fund. You are allowed access to the fund only after retirement or in line with the 2-pot system.

The trustees of the pension or provident fund manage the underlying fund options, choosing which financial instruments to invest in and how much money to invest in each. They also determine the level of risk associated with these investments. The fund typically has an arrangement with its investment managers and financial advisers that allows you to benefit from perks such as discounted rates and financial planning assistance. In contrast, you’d take out a personal retirement annuity (RA) as an individual to subsidise your current pension or provident fund contributions, or because you don’t have a pension or provident fund.

The Office of the Ombud for Financial Services Providers explains that RAs offer multiple investment options, ‘including equity funds, balanced funds, fixed-income funds, and money market funds.’ You can also choose an investment strategy that will align with your risk profile and investment goals.

Do you need an RA and a pension fund?

There are a variety of factors that you should consider. What works for your friends or family may not be ideal for you. Consult your financial adviser for expert guidance based on your personal circumstances.

Answering the following questions may help you clarify what suits you best:
 

1.  How much risk are you willing to take on?

Saving for retirement is investing for the long term. Generally, the longer you invest, the more risk you are willing to take on. A 28-year-old who starts employment has a 32-year investment term if they retire at 60. A 57-year-old employee, on the other hand, has only 3 years left to retirement age.

In our example, the 28-year-old is probably willing to take on more risk over the long term and therefore reap more rewards on returns. The 57-year-old is less likely to take on as much risk and will therefore invest in underlying funds that are more conservative. This debate becomes more interesting if the 57-year-old decides to buy a living annuity at retirement and therefore remain invested in the same funds for a further 20 to 25 years.

If you belong to a pension or provident fund, the trustees elect underlying funds that they consider appropriate for you. These are often more balanced funds. An RA, however, generally has many more underlying fund options – these include more aggressive funds that generally offer larger returns over the longer term.

2.  Do you want to be in charge of your retirement savings? 

You need a level of understanding of your risk profile and available underlying funds to manage your own RA. Alternatively, you can also get a financial adviser to help you choose an underlying fund or funds.

If you want to supplement your retirement fund but don’t want to go through the process of finding the right underlying funds in an RA, it may be easier just to increase your current pension or provident fund contributions. If, however, you want control in terms of how much you contribute, your underlying fund choice and your ability to transfer to a competitor at any stage, an RA might be more appropriate for you.

3.  Are you willing to spend extra on admin fees for an RA? 

Trustees of pension and provident funds can negotiate ‘institutional’ rates. RA members, however, generally have access to retail rates only – so you’ll usually get better rates on a pension or provident fund.

As you can see, this isn’t a matter of choosing a pension or provident fund vs choosing an RA – being a member of a pension or provident fund is usually a condition of employment. If you’re not a member of a pension or provident fund, contributing to an RA makes perfect sense.

What you should be asking, if you’re a member of a pension or provident fund, is whether you want to increase your retirement savings, and whether you should do so by increasing your contribution to the pension or provident fund, or by investing in an RA. We hope that this information will help you make that decision.

At Nedbank, we offer a range of retirement options tailored to your needs. Contact our experienced financial advisers for expert help in planning your retirement journey.