Should you include risk assurance cover in your Retirement Annuity?
You can combine risk life and disability assurance with a
Retirement Annuity (RA) in a single policy. (No risk assurance can be linked to a preservation fund.) There are advantages and disadvantages to doing this. You need to consider the following issues:
- You can claim risk assurance premiums attached to an RA against your taxable income. However, you may still not exceed the limits for tax-deductible contributions to RAs. This means that in future when you may want to increase the savings portion of your RA, the premiums for the risk cover may no longer be claimable. So, you can only benefit from the tax deductions while the combined premium is less than the tax-deductible limit.
- On death, the life assurance benefit of an RA is taxable because the total contributions have been claimed as a tax deduction. The proceeds of a free-standing risk life policy are not taxable in the hands of your dependants, beneficiaries or estate. This is because premiums paid for such a policy cannot be claimed as a deduction against your taxable income.
- You cannot decide how the life benefit attached to an RA will be distributed. Although you may name beneficiaries, the proceeds must be distributed to dependants in terms of the Pension Funds Act.
In terms of the Income Tax Act, your accrued RA investments, as well as the risk benefits, are treated as a single amount and must be distributed as part lump sum and part pension. This means at least two-thirds will have to be used to buy a pension, while the tax structures for lump sums apply. The annuity portion will be taxed in the hands of the recipients at their marginal rate of taxation.
With free-standing risk life assurance, you decide on the beneficiaries and the entire amount is paid out as a tax-free lump sum.
- The life cover attached to an RA ceases on maturity of the RA. When your RA matures and your life cover ceases, you will be older and more likely to be in poorer health. These factors will count against you when you try to get life cover.
- You will be penalized if you reduce your premium or make the RA paid-up. There will be two consequences if you make the RA paid-up. Your accrued investment will be reduced by the amount of the penalty. Any remaining amount, if there is any, will be used to continue to pay the risk premiums, unless you specifically cancel the life cover as well. The penalty will then be larger as it will include the calculations on un-recouped costs on both the investment portion as well as the risk portion. If you do not cancel the risk cover, your risk cover will lapse when the accrued investment amount is used up.
This ability to draw down on your accrued investments to pay risk cover can be both an advantage and a disadvantage. If you have lost all sources of income, you will at least know you still have life cover, but this comes at the expense of your retirement savings. If and when you lose the life cover because the investment amount is used up, you then face the prospect of having to take out a new life policy.
- Your need for risk cover will change according to your lifestyle. For example, if you have children, you will need more cover when they are living with you than when they leave home.
You have more options and flexibility if you have a straight life policy. You can reduce the cover on the policy without incurring any penalties.
- Risk life assurance is becoming more competitive, and better and cheaper risk cover is being provided. You can cancel an ordinary life policy without any financial penalties being applied. There is no investment portion, so there is nothing a life assurance company can confiscate by way of penalties.
As a general rule, you should keep your risk assurance separate from your investments.
To learn more about the top ten things to know before buying retirement annuities