Retirement Annuities and the Power of Compound Interest

Do you know someone, like Baba, who has worked hard almost all of their life but who only has access to the government funded pension scheme when they retire?
Would you like to have more options when you get to retirement age?
Do you think that retirement is so far off that there’s no point planning for it now?
What about life cover? Have you thought about what would happen to your family, should you pass away or find yourself unable to work earlier than you planned?

As uneasy as thinking about old age and death makes us, it really is something to plan for as early as possible. In fact, if you plan for unexpected events, and even expected events, such as retirement, you will be able to rest easy knowing that your financial future is covered. And, the bonus is, the younger you are when you start investing in policies such as life cover and retirement annuities (RAs) the cheaper it is!

Baba has reached retirement age. He no longer has the energy or the desire to work full days, however he remains an active man. He is taking care of Khwezi while Samke is out working. He realises too late that he should have thought more about his retirement when he was a much younger man. He will go to the SASSA offices and claim his government pension but it really isn’t as much as he’d hoped to have at this late stage of his life.

Baba hopes that Samke, now that she is earning money and has a child to think of, will start her retirement plan soon. He knows that, working for herself, Samke won’t be contributing to a work-based pension plan but that is no reason why she can’t prepare financially for the future.

One of the best ways to save for your retirement is to take out a retirement annuity (RA).

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What is a retirement annuity?
An RA is a long-term investment for anyone wanting to save for a comfortable retirement. Anyone can take out an RA, it is especially good for business owners and others who earn irregular incomes, such as commissions. Even if you are contributing to your employer’s pension fund, you can still have an RA.

When you retire, you can withdraw a taxed lump sum of up to one-third of your RA’s value. The two-thirds balance is used as a living annuity, which means that you can draw on it during retirement. The living annuity is paid out monthly, quarterly, half-yearly or annually according to the South African Revenue Services’ guidelines.

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Key points for planning your retirement

Do some research
Do some research and find out what sort of plans are available for retirement. Many different insurance companies offer RA policies. Find a trustworthy financial adviser or reputable insurance company so you can begin investing in your RA.

Start early as time is your friend
The earlier you start paying into an RA, the more money you will have for your retirement. In fact, the money will grow a great deal with compound interest (more on this later).

Retirement is a long-term savings goal
One of the benefits of an RA is that you can’t withdraw any of the money before you are fifty-five or retire. South Africans have a poor record when it comes to saving money, so this is a benefit. Also, the longer you save, the more money you will have for retirement.

Invest at the ‘right’ risk for you
When you invest in an RA, the money is invested in different funds that have varying risk profiles. This means that some funds are considered ‘safer’ investments but they may grow more slowly, while other funds are considered more ‘risky’ investments but they could see huge gains (or losses) depending on the markets. If you start young, you can afford to take more risk as there is more time to grow your investment. Your financial adviser can help you decide the right risk profile for your RA.

How much to invest?
If you have a monthly budget, you will be able to work out how much money you can invest in an RA. However, should you have a windfall, don’t blow it – put it into your investment and you will reap the rewards later!

Save on your tax
If you are in a job where you pay tax on your salary, you can save some of the money going to the tax man by putting money into your RA. Money invested into an RA is taken off your taxable income. You can invest up to 27.5% of your annual taxable income in your RA.

Review annually
Most importantly, review your plan with your financial adviser once a year to ensure that you are still on track.

It may be that, after a few years of investing, you want to increase your payments into your RA. Keep an eye on the growth of your investment and make changes annually.

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Retirement and compound interest

Compound interest is a wonderful thing! It is an effortless way of growing your money in an investment. Every month the interest you earned on your investment is added to the money you have invested and, because you don’t withdraw your interest, your money grows. The following month you will earn interest on your original investment plus the previous month’s interest, so you earn more interest every month. In this way your money simply grows and grows …

The earlier you start investing in either an RA or any other long-term investment opportunity, the less you need to put in in the long term to ensure a comfortable retirement.

Ideally, if you start an RA at age twenty-five years, it’s recommended that you invest up to fifteen per cent of your gross income. Realistically, this may be too much as you start building your financial future.

If you earn R15,000, you could start by investing R400 a month into an investment account from which you will not draw any money until you reach retirement. The sooner you start, the easier it is.

Here is an example of how compound interest grows your money over forty years:

As you can see from this table, you have not increased your monthly premium of R400 over forty years! You have contributed a total of R192,000 but, when you retire, you will have grown your money to R2,336,889! That’s growth of more than two million rand.

That’s the beautiful power of compound interest!

Of course long-term financial planning also includes taking out other types of insurance.

Here are some other options:*
● Life insurance (payable to your family when you pass away)
● Income protection (payable in the event that you become disabled)
● Critical illness (Payable when you suffer from a major condition such as a heart attack or cancer)
● Funeral cover (payable when you or any family members that are covered pass away)
● Credit life insurance (often used as cover for payment/settlement of a debt should you pass away)

Should you decide to invest in any of these long-term policies, many of the key points of planning for your retirement are useful as a guide. Remember to plan, research the policy (always read the fine print), execute and review annually.

In the story, Samke might think that paying into an RA at her young age doesn’t make sense but, if you think about it, the more she pays in now, the less she will need to pay in later.

It might seem an unnecessary expense to pay in R400 of a R15,000 salary when you are twenty-five but think about the salary increases that will happen as the years go by. Perhaps, by the time you are forty-five years old, you will be earning over R25,000 but you can still only pay in R400.

This person will have the option of paying more or even less – if household expenses become extremely high at that stage – and have the security of a stable financial future. This is far preferable than paying thousands of rands extra a month if you only start at forty-five and wish to have a similar pension amount!

Think about your long-term future and what your current picture is of your retirement. Can you change it drastically by financially planning for your retirement? Yes, you can! You can avoid some of the lumps and bumps of life’s journey by creating a safety net for yourself and your family by investing in your future.

Find out more information here

* This information was supplied with the support of Shameer Chothia from Momentum Consultants and Actuaries. Shameer is a financial coach in his spare time with an ambition to educate people on financial education.