When you retire, you have two important choices to make with your retirement savings. These decisions require careful thought, which could have a material impact on your retirement lifestyle.
Decision one: Taking a lumpsum? If so, how much?
The amount an investor can withdraw as a lump sum is determined by the pension fund of which they are a member. The first R500,000 withdrawn in your lifetime is tax free. Any cash lump sum withdrawn reduces the purchase value of a post-retirement annuity which will provide you with your retirement income.
Decision two: Where do I invest the rest?
There are two annuity options or a combination thereof, that will provide you with a retirement income for life.
A) Guaranteed (Life) Annuity
A guaranteed pension for life from an Insurer who agrees to pay you a set income for the rest of your life. The Insurer carries the risk.
Typically, you only have the choice of your level of income and how much this income will escalate every year. You can either select a fixed amount with no annual increase which will result in your spending power reducing as inflation increases. Alternatively, you can select an escalating income amount which increases by a predetermined percentage or at inflation (CPI) each year, but the initial starting income will be lower if an escalation is selected.
Three major negatives are:
- On your passing, there is no residual capital to leave to your dependents or estate.
- You cannot make any changes or transfer into another investment product.
- You have no flexibility to increase or decrease the income that you earn for the rest of your life as this is predetermined at the start of the investment.
B) Living (Market-Linked) Annuity
When choosing a Living Annuity, your savings are invested in a portfolio of underlying assets, such as unit trusts. Once a year you can set your level of income (between 2.5% and 17.5% per annum) of your total investment.
You can decide to transfer a living annuity to another product provider or convert it to a guaranteed life annuity. As a Living Annuity, the capital remaining upon your death is inherited by a nominated beneficiary.
The major negative is:
- You carry the investment and longevity risk as your selected income payment is not guaranteed. Your investment value can fluctuate depending on your chosen investment options. Using the services of a qualified financial planner is recommended to manage the sustainability of your income withdrawals/requirements and ensure that your portfolio is invested correctly.
At retirement, careful consideration needs to be given to the amount you draw as a cash lump sum from your retirement funds, as various tax efficiencies can be attained depending on the size of your retirement funds and your required monthly income. For example, it may be more beneficial to pay some initial tax upfront (above the R500,000 tax free threshold) in order to structure your investments more effectively.
We believe that the flexible benefits of a Living (Market-Linked) Annuity far outweigh the guaranteed income of a Guaranteed Life Annuity, which currently provides a drawdown of around 4.5% after tax on a R10 million retirement value with a 5% annual escalation.
In order to match a guaranteed rate of income over a 25-year period with capital depleting, the Living Annuity would have to produce a 10% annual investment return. Over the last 25 years, the average moderate-risk fund (multi-asset medium equity unit trust) has produced an 11% return per annum.
Therefore, planning your retirement investment with a tax-efficient structure that incorporates a Living Annuity should provide a higher long-term income than a Guaranteed Annuity. This will provide a better lifestyle with more income flexibility, plus the peace of mind that your dependents will receive residual capital within at least a 25-year period. It is vital that you have a qualified financial planner to guide you through the selection of the most appropriate structure and strategy.
Speak with one of our qualified Client Portfolio Managers to assist with your retirement plan.