Decisions you will need to make when you retire: Part Two- Retirement Income Strategy
You will need to make a few important decisions when you retire. Part Two of this three-part series covers how to structure your retirement income.
One of the most important decisions you will make when you retire is how to structure your income. While your specific requirements and provisions will be unique to you, and proper planning is incredibly important, this piece illustrates how a fairly simple strategy can provide great value.
Background
As a general rule, we typically advocate for a blend of retirement and voluntary investments when building towards retirement.
Pre-retirement wrapped investments, such as Retirement Annuities, Pension Funds, and Provident Funds, provide excellent benefits through annual tax relief on the contributions - subject to generous annual limits, tax-free growth, and reduced costs and taxes at death, as tax-deductible contributions plus growth thereon don’t form part of your estate. When you draw an income from these investments, the income is taxed as normal income. The annual rebate on contributions is therefore more a tax deferral than a tax saving, but because we receive it every year, we can re-invest that money and enjoy compounding growth on it in the meantime, so this deferral is a powerful tool.
The best plans are flexible
Life is not predictable. We often get thrown curveballs. Flexibility is incredibly important, as a major life or health event or unforeseen expense could trigger an ad hoc lump-sum cash requirement or a higher level of income for a period of time.
Post-retirement, the annual income from a life annuity is set at inception and the annual drawn down from a living annuity is set annually, in advance, and is limited to a range of between 2.5% and 17.5% of the fund value.
Enter Voluntary Investments
Voluntary investments, such as local or offshore Unit Trusts, Tax Free Investments, Endowments and Share Portfolios do not provide the same tax benefits but offer much more flexibility to withdraw as and when required.
Voluntary investments also allow you to obtain a suitable balance of assets while building towards retirement, as pre-retirement wrapped investments are governed by Regulation 28 of the Pension Funds Act, which limits exposure to shares and offshore investments.
What’s the solution?
By drawing part of your income from voluntary investments, you reduce the required draw down from your retirement wrapped investments. This is favourable from a tax perspective because a drawdown from voluntary investments is not taxed as income. Tax Free Savings Accounts attract no tax on growth, so withdrawals can be seen as a tax-free income stream. The tax treatment of money invested in Unit Trusts is dependent on which asset class you’re invested in. Interest in excess of the annual exemption is taxed as normal income. Dividends are taxed at a flat rate of 20%. Withdrawals on shares triggers a capital gains event, and 40% of capital growth applicable to the withdrawal (Market Value of the investment less its Base Cost), is taxed at your marginal tax rate after applying the R40,000 annual exemption. The highest possible capital gains tax rate for an individual is therefore 18% (included at 40%, taxed at 45%).
Additional Benefits for Married couples
If you are married, by building your retirement provisions (both retirement and voluntary investments) in both spouse’s names, you can each draw from your respective investments. This reduces normal tax attributed to the retirement investment drawdown and provides both of you with access to the annual interest and capital gains tax exemptions.
In summary
This is clearly a very simplified explanation of what is possible but it does illustrate that through proper planning, you are able to appropriately cater for your retirement needs, maintain flexibility, achieve your desired and required asset allocation and diversification, while reducing your tax bill – both pre- and post- retirement.
Jonathan Theunissen, CFP®
Financial Planner
