Despite which investment vehicle you choose to grow your money, either a unit trust or ETF or both, you will invariably need to choose the type of account that houses these vehicles. Each type of account is governed by different laws and legislation. Thus, it’s extremely important to understand the implications of these accounts.
There are three general account types investors can choose from, others do exist but they are beyond the scope of this article. The three account types are a standard investment account, a tax-free savings and a retirement annuity. The financial service provider you use may have different names for these accounts but the laws and legislation governing each should be the same.
Standard Investment Account
A standard investment account is the most flexible account type. You should be able to add or withdraw almost any amount of money as and when you see fit (note, the minimum amounts for each service provider may differ).
These accounts attract the same tax implications as those that you are already exposed to as an individual. Any income will be taxed according to income tax and any realized capital gains will be taxed according to capital gains tax.
Tax-free Savings Account
A tax-free savings account is less flexible than a standard account, but in exchange for limited flexibility there are tax savings. These accounts may also only invest into specific types of unit trusts and ETFs but is not generally limiting, and more something to be aware of.
Generally these accounts limit the amount you may add in a single tax year, but you are able to withdraw whenever you need. All income generated in the account and any realized capital gains are then tax free.
This is the most complicated of the three accounts. A retirement annuity is the least flexible account type but carries the greatest tax benefits. These benefits come in the form of all income and capital gains generated in the account being tax free, as well as the ability to reduce your yearly taxable income by the amount you contribute towards a retirement annuity.
However, this too has yearly limits but you will inevitably reap the benefits down the line. The money that is in these accounts is generally locked in for a specific period of time, and the government usually sets a retirement age at which point you may have access to your money.
The amount of money you may access though, depends on the amount of money you have in the account when you retire. Further, although there are tax benefits while the retirement annuity is active, this situation changes when you access your money. Firstly, if you opt for a lump sum payment at retirement (subject to restrictions) this may be taxed.
Secondly, once you retire from the fund the next phase is to draw an income from the balance of the account, these drawings may be subject to tax. I realize that the above is very high level, the reason is because tax laws change annually and this description is just meant to provide an overview.
Since these accounts have retirement in mind, and the government has a vested interest in you having enough money at retirement to look after yourself, they generally place limits on the asset allocation within the retirement annuity. The apparent purpose of these limits is to prevent overly risky investments, and hopefully reduce the risk of the individual having insufficient retirement savings.
The question of; which is the best retirement annuity, is somewhat of a misnomer since the performance of the retirement annuity is subject to the performance of the investments within the retirement annuity account. And the amount of different ways to structure the investments is essentially infinite.
Next: Asset Classes