Unit trusts are an excellent underlying investment for retirement annuities (RAs), offering a number of benefits.

“RAs that give investors access to outperforming unit trusts remain one of the best savings vehicles for retirement over the longer term,” says Johan de Lange, managing director of Allan Gray Investor Services.

As an investment product, RAs have a number of advantages — if properly structured. The biggest advantage is their tax-efficiency. RAs were originally developed to give self-employed people the same incentive to save for retirement as employees of companies with pension funds and can be structured in a number of ways.

“Unit-trust based RAs are available without the drawbacks of conventional product structures. They can be, and are, offered with low product fees, no penalties for surrender or discontinuation and fully transparent and negotiated advisor fees,” says de Lange.

Investors who do not contribute to a pension fund can invest 15 percent of their taxable income into an RA tax-free. Those who currently contribute to a pension fund can contribute 15 percent of any income that is not taken into account when calculating their pension contribution tax-free. Any additional payments (over the 15 percent limit) may be carried forward and offset against future taxable income.

RAs also ensure that savings are preserved for retirement purposes, as capital can only be drawn when the investor reaches retirement age (between 55 and 70). At retirement, after deduction of the investor’s permitted tax-free amount, the rest of the funds in the RA are taxed at the investor’s average tax rate.

At retirement, while a minimum of two-thirds of capital must be invested in a pension-providing vehicle such as a living annuity or guaranteed life annuity, no tax is levied on the transfer of capital into such vehicles. Thereafter, once retired, the investor’s annual pension is then taxed at the individual’s marginal rate, which is likely to be lower than his or her tax rate prior to retirement.

“The fact remains that investors increasingly have to make provision for their own retirement savings.”

In addition to transparency and low costs, the benefits of unit trust based RAs in particular include choice and flexibility. Investors can choose the underlying funds they want to invest in, and can switch between funds at no extra cost. In addition, unit trusts are an ideal home for longer term investments and retirement savings are by definition longer term investments.

“In order to benefit from the superior returns over the long-term from unit trusts, investors have to live with the risk of a certain amount of shorter term volatility. They are able to do so in retirement savings vehicles such as RAs because of the time horizons of these products.”

In conclusion, de Lange says that the danger of waiting for legislative change to more traditional RA product structures means that investors will be faced with the opportunity cost of delay. The remarkable returns of the past few years already represent a massive opportunity cost to those who delayed contributing to an investment.