Retirement Annuities vs property: Round 2

Visitors responded vigorously to an article by Realestateweb editor Jackie Cameron on why property is a better investment for many individuals. She reckons you should ignore the tax benefits of ploughing hard-earned savings into a Retirement Annuity (RA) and invest in property instead for long-term income purposes. Financial intermediary Noel Williams is among the army of readers who disagree. He presents the case for Retirement Annuities as time runs out for individuals to tax advantage of the annual tax perk. Read the original article by clicking here or on the related article (Don't fall for RA tax perk hype), and share your views on this important investment issue below this article.

As someone who has been involved in the financial services industry for many years, I would like to take issue with your article that appeared in the Citizen newspaper on the 13th February 2010.

A problem with financial journalism is that articles that appear in a major publication enjoy a level of credibility that is not always justified. Based on the content of your article, I would suggest that this is certainly the case here.

Your message in the article in question clearly rubbishes R/A's, and suggests one should rather invest in residential property, ostensibly justified by your friend's experience in the early 2000s.

Let's first consider your example of an investment in residential property. I am the first to support the view that, given the correct set of circumstances, residential property can and has been a superb investment, particularly for those who were fortunate to invest around the turn of the century.

However, as you might have noticed, investment circumstances and conditions have changed drastically over the last couple of years. eg.

1. Even with the recent drop in residential market prices, property prices are often around 3 x what they were 10 years ago.

2. Property market yields (rentals) which were close to 10% in those days, have dropped to between 4% and 5%.

3. Given relatively high current prices and low rentals (if you can find a reliable tenant) one can no longer put down a small deposit and expect the rental to cover payments on the outstanding bond.

Currently the investor would have to personally cover a significant portion of the bond cost, and given that growth rates of 25% plus now belong to the dim and distant past, one clearly has to seriously consider whether this type of investment would be justified under current market conditions. Capital growth is clearly no longer a given.

4. Today, one would need a fairly significant capital amount to enter this market. R50 000 would definitely no longer do the job, unless you wanted to buy a very small cottage in rural Kwazulu-Natal.

Fundamentally there are significant differences between the two options.

1. PROPERTY

In the case of property, a significant amount of start up capital is required, and the positive benefits of gearing only occur when a variety of factors work in the investors favour. Property as mentioned earlier, can unquestionably be a great investment, but given the wrong set of circumstances and market conditions, could lead to the investor losing his or her boots. Right now I would suggest the latter is more likely to be the case.

2. RETIREMENT ANNUITIES

If you enjoy a reasonable marginal tax rate (i.e. 30% plus), and in terms of the R/A tax regulations, you have capacity to benefit from allowable tax deductions, there is absolutely no doubt in my mind that it makes sense to take advantage of the tax breaks offered.

Let us start with a given. I will use the example of an individual at a marginal tax rate of 30% which kicks in at about R200 000 per annum or R16 600 per month. Let us assume a worst case scenario and that an R/A investment shows a zero % return before the tax allowance; this would in fact mean an effective 42.8% return to the investor.

CALCULATION OF INVESTMENT RETURN

INVESTMENT AMOUNT                  INVESTMENT YEAR END (0% GROWTH)

         R100  .................................  R 100
Tax Allowance   R  30                         Growth  R 30 x 100 = 42.8%
Investment Cost R  70                                      R70

Assuming a loss of 15% on the same investment, it would still show a return of 21.4%.

Given a positive investment return, or a higher marginal tax rate, the returns would clearly grow significantly.

Clearly, retirement annuity portfolios, as is the case for any other investments, have to be well managed and the investor must be in a position to deduct his investment against tax. If not, he might just as well consider a unit trust investment.

In conclusion, I would like to suggest that you reread your article and take note of the generalities you have expressed, and your implied conclusions which I believe have little relevance in today's markets.

In addition, I would suggest that you have your existing R/A's reviewed by an experienced, qualified investment adviser. The portfolios you have alluded to clearly need revisiting to establish why their performance has been so disappointing.

Finally, I would suggest that there is absolutely nothing wrong with the Retirement Annuity vehicle, but it has to be appropriately marketed after carrying out a detailed needs analysis to address each individuals personal set of circumstances.

Article by: www.rawsonproperties.com