Decisions you will need to make when you retire: Part One - Retirement Funds

You will need to make a few important decisions when you retire. Part One of this three-part series covers retirement funds.

1. How much in cash?
 
For a Pension, Pension Preservation or Retirement Annuity Fund: When you retire, you are entitled to take up to (a maximum of) one third of your retirement fund balance as a cash lump sum.
 
For a Provident fund or a Provident Preservation fund: When you retire, you are entitled to take the full balance in cash.
 
These cash lump sums are taxed according to the Retirement Lump Sum Tax Table. The first R500 000 will be tax free, provided you have not taken any previous lump sums in your life. Lump sums are taxed cumulatively, on a sliding scale. When you take a lump sum, all lump sums you have taken in your life are added together, the total taxation is calculated and then the taxation paid on previous lump sums is subtracted from this total to give you the taxation payable. In simple terms: the more lump sums you take in your life, the more tax you will pay on them. It is therefore to your advantage to take as few lump sums as possible in your lifetime, so as to minimise the long-term tax impact.
 
2.How much should I use to invest in/buy an annuity?
 
For a Pension, Pension Preservation or Retirement Annuity Fund:
You have to use (a minimum of) two thirds of your retirement fund to either purchase or invest into an annuity. This annuity will provide a monthly income for you until the day you die. The more money invested into/spent on an annuity, the higher the potential monthly income will be.
 
For a Provident or Provident Preservation Fund:
You are not compelled to purchase an annuity. Taking the whole balance in cash could result in significant tax being payable on the lump sum, however. You would also then have to use that money to produce a monthly income until you die, whilst keeping up with the demands of inflation. A potential minefield of issues that could be better navigated by using a portion of your Provident Fund to purchase/invest in an annuity.
 
3. What kind of annuity should I buy?
 
There are two broad types of annuities: Life and Living annuities.
 
With Living Annuities, the capital is invested into Unit Trusts. This means that the market value of the investment will fluctuate with market movements: The Living Annuity could increase or decrease in time depending on level of drawdown and market movements. You must draw an income from the Living Annuity at a rate of between 2.5% and 17.5% per annum. This is taxed in the same way as a salary (Pay As You Earn is withheld before it is paid out to you). This level of income can be adjusted once per year on your anniversary date (The anniversary of the date the Living Annuity comes into operation). This income will need to be managed carefully. Taking too large an increase when your investments have performed poorly will eat into your capital. Taking increases at times of good performance help to ensure that the capital will last longer.
 
An advantage of Living Annuities is the capital can be inherited by a beneficiary on the account. This means that in the event of your death: The Living Annuity can pass to your spouse. Once your spouse passes away the Living Annuity can pass to another beneficiary etc.
 
The ability to manage the income percentage each year and select the underlying investment within the Living Annuity is also an advantage.
 
A downside of a Living Annuity is that the investment will be subject to market fluctuations. There will be good years and bad years, and the income will need to be carefully managed to ensure that the capital lasts.
 
Life Annuities are purchased from insurance companies. In exchange for your capital, the insurance company guarantees that you will receive an income until your death. This is taxed in the same way as a salary (Pay As You Earn is withheld before it is paid out to you). Various features (insurance) can be built into this annuity. You can choose to receive a compulsory inflationary increase. You can also choose for your spouse to inherit between 25% and 100% of the annuity after your death. Each feature added comes at a cost and will result in a lower starting income.
 
The advantage of Life Annuities is that you do not have to worry about preserving capital and managing the level of income. If a compulsory increase is selected: you will receive a monthly income each month until you die, that will increase each year by the selected increase percentage.
 
The disadvantage of Life Annuities is that once you purchase the annuity from the insurer: the capital is gone. The monthly income can be inherited by your spouse in the event of your death, but once your spouse passes away the income will cease to be paid.
 
Please get in touch with your Verso Wealth Financial Planner if you’d like to discuss the next phase of your life and the important decisions you will need to make.

Brendan Dunn CA(SA), CFP®
Financial Planner