Group RA versus cash: which one is the smarter financial choice?

Question

I am from the UK and have been working in South Africa for a couple of years. I am a South African taxpayer and intend returning to the UK in about five years’ time. My employer has given me the option of either:

• contributing R350,000 per year to a group retirement annuity (RA); or
• taking the R350,000 as additional salary and investing it myself.

Which option should I take?

Answer

That your employer offers employees a group RA is a big positive. The way it works is that instead of a company pension fund, each employee has their own RA that is paid for by the company. When you return to the UK, the policy remains yours and is not tied to your employer.

I will run through the various pros and cons of each option to help you make an informed choice.

Taking the RA option

There are a few features of an RA that you need to consider:

• Immediate tax relief: I have assumed that as your employer is offering the R350,000 retirement payment, your marginal tax rate is at least 41%. The R350,000 that your employer will be contributing on your behalf will give you a tax rebate of R143,500 each year – a saving of more than R700,000 over the next five years.

• Tax-free growth: All growth inside an RA is tax-free. Over even a relatively short period like five years, this significantly boosts outcomes compared with discretionary investments.

• The two-pot system helps: Under the two-pot system, you can access one-third of your retirement savings before retirement. If the RA value after five years is about R2.14-million, you could withdraw about R712,000.

This withdrawal is taxable, so timing matters. If you make the withdrawal after you stop working in South Africa, your taxable income will be low or zero, meaning the effective tax rate could be minimal if withdrawals are staggered over more than one tax year.

Pension

The remaining two-thirds must be used to purchase a pension after age 55. Having money invested in SA while living abroad is not necessarily a bad thing. Diversification across developed and emerging markets can improve long-term outcomes.

When you want to access these funds, my recommendation is that you make a withdrawal once a year of between 2.5% and 17.5%. If you want to get your funds out of SA as quickly as possible, you can withdraw 17.5%. As you can see in the table below, the capital will gradually reduce if the investment is earning 10% and you are withdrawing 17.5%.

Insider tip: Withdrawing after you stop earning local income dramatically reduces tax paid on the annuity.

What if you take the cash instead?

If you take the R350,000 as part of your salary, it is fully taxable. Assuming a 41% tax rate and the same 10% investment return, the numbers look like those in the table below.

At the end of the five-year period, you will have about R1.2-million to use as you please. This is about R1-million less than the RA option.

However, as I have shown, there are restrictions on how and when you can access these funds. I would recommend that you discuss these options with a financial planner. DM

This story first appeared in our weekly DM168 newspaper, available countrywide for R35.