Contribute more to a Retirement Annuity or go Offshore and pay CGT? – Why a South African RA isn’t for me on my journey to FIRE

I started this post with the intention of explaining why an RA isn’t for me. I’ve been skeptical for a while now that it’s advantages outweigh the constraints for disciplined investor. So, I built a model to prove my point. Only it didn’t. It didn’t disprove it either. In short, it depends.

This post is not for someone looking for a simple plan.

The non-financials

There are some brilliant reasons to have an RA, such as disciplined and structured savings, a deferred tax wrapper, protection from others (can’t be claimed in bankruptcy) and yourself (limited to drawing down when you are over 55).

But, I assume you are reading this to challenge some of your thinking.

I moved back from the UK to a land filled with opportunity and potential, albeit some of it latent. I still have a pension set up in the UK, which has far fewer restrictions than those of Reg 28. Reg 28 is meant to smooth performance by sacrificing some return, but until I am drawing down, I don’t care about volatility.

I personally think Reg 28 should be revised to closer match life-stage strategy funds. Besides as I am targeting FIRE (Financial Independence Retire Early), only be able to access the wealth when I’m 55 does not fit in with my plan.

I think that everyone should always start by building a similar foundation on the Personal Finance Journey.

• Emergency Fund – 3-6 months of expenses liquid
• TFSA – Max every year
• RA – 10%-20% of salary

Having those in place, reduces finance anxiety and stress.

Simplicity is often key, as we don’t inherently have the discipline and focus for something complex, we end up doing nothing.

This post is for those on a FIRE journey, those with a savings/investment rate well in excess of the 20%. It is for those who are interested in the RA vs. Offshore Equities (Or any asset class, if you tweak the model).

So, I built a model. Tax tables and all.

The Assumptions

I am not a tax expert and this was a completely academic exercise. I do have a lot of experience creating financial models. Of course the creator is also aware of the limitations.

I’ve made some pretty significant assumptions, such as:

• Tax rates don’t change.
• I’ve ignored inflation or rather assumed a inflation adjusted return.
• I’ve ignored volatility in return – I’ve assumed FIRE’ees can time their exit, in a way timing the market.
• I’ve ignored currency volatility as the risk is usually priced in to some extent.
• I’ve ignored re-balancing between asset classes – which has been shown to enhance return as it scaffolds in sell high, buy low.
• I’ve assumed income stays flat – lifestyle tends to adjust accordingly (Parkinson’s Law – second interpretation).
• I’ve ignored dividend leakage and rather lowered the return expectation.
• I’ve ignored RA Maximums.
• Ignored Tax Free amounts.

The amount of assumptions and starting points should give you a hint to the limitations of a model.

Building the Model

Starting Parts – Can be changed

• CGT is taxed at 1/3 of Income Tax and I’ve assumed it’s the Satrix MSCI World (Although I actually go USD into a Vanguard fund)
• Future Draw Down rate of 5% (I personally think the 4% rule is too high, provided you are flexible) – it can easily be changed though in the model
• I’ve based the RA portfolio on the Sygnia Skeleton Fund as potentially the most attractive option
• Although I’ve said offshore – I’ve started with Satrix MSCI World – Which is Rand denominated, but the underlying assets are predominantly in USD (66%).
• Inflation adjusted returns are generous or conservative, I’ll let you know later

Building the Model – Questions to be answered

Question 1 – RA or CGT Route – Straight Comparison

Question 2 – What should the balance be – Life is seldom binary and building one on top of they other.

Question 3 – Phased – What if I did one, then then other.

Scenario – R300k per year, with annual expense of R180k

Scenario – R600k per year, with annual expense of R360k

Scenario – R900k per year, with annual expense of R540k

Scenario – Rxk per year, with annual expense of Rxk – Test it for yourself.

I’ve probably made some dumb assumptions and everyone’s circumstances are different. So I reckon you should have a go yourself.

Scenario – PF40 – How does this impact me?

I changed the assumptions to fit my personal context, for example, I believe as long as I’m not at lean FI, I can use a 6% draw down rate, but need to watch it. I can reduce expenses or supplement my income. I’m also expecting to increase expenses after FI depending on the next adventure.

With my numbers. It takes 14 years before CGT is preferable, but by then I am targeting being FI for about a decade. After 4 years (My FIRE target), I’d be better off with an RA, but I couldn’t access it. It’s also a bit moot, as my investment rate is 48% on gross salary and 71% on net (which is probably a better like for like of the 76% RA rate), so well beyond the 27.5% allowed. Even assuming I maxed it, I couldn’t find a phased approach, beyond a few years, where it was beneficial.

For me, it’s CGT route offshore for the foreseeable future. I have a pension, which if I don’t touch until I’m 67, which should leave me comfortable (or at least give me a great chance of being comfortable).

Of course – Increasing the savings rate, still has a far bigger impact that choosing which vehicle to invest in.

What is your tipping point? Should you change your balance?