If you are close to retiring, it’s perfectly understandable that you may be feeling a little nervous as this major life change approaches. It’s human nature to be anxious about changes to your routine – even when it’s a positive lifestyle change (less stress and much more free time).
Nagging doubts as to whether you have accumulated sufficient retirement capital can also cause anxiety. If you watch your retirement capital balance daily, then any negative fluctuations could raise fresh concerns on this score.
Like many people, you probably have numerous investment vehicles that you will need to decide what to do with when you retire. These could include discretionary investments like unit trust investments, endowments, tax-free investments etc and pension money like retirement annuities, a provident fund, pension fund or preservation fund. A great deal has been written about whether to take a lump sum at retirement and, if so, how much (given the retirement tax implications).
I believe that you should take a lump sum where the tax paid on the lump sum will still be less than the marginal income tax rate you would pay if you were to take a monthly drawdown. To make an informed decision, you need to know what the impact of taking the lump sum will be on your monthly drawdown.
Rather than look at pre-retirement advantages and tax benefits, in this article I will focus on the implications of post-retirement decisions. If you have taken a lump sum from your retirement fund as recommended by your financial planner, you need to decide how best to take a drawdown from the capital that you have saved up in your various investment vehicles.
My advice would be not to consolidate your discretionary money with your pension money. Assuming you decide on a living annuity (as 80% of South Africans do), yes, there will be certain estate duty exemptions on your pension money, but there can also be exemptions on your discretionary money if you nominate the beneficiary correctly.
Let’s look at the monthly tax consequences:
Suppose you have R5 000 000 saved up in pension money and R3 000 000 saved up in discretionary capital, such as direct investments, endowments and the money markets, and that you are aged 55 and will take an annual drawdown of 5% on your total investment value.
Consolidating everything into pension money where you can draw between 2.5% and 17.5% per annum, the total value would be R8 000 000. This equates to R33 333 drawn before tax each month (5% of R8 000 000, divided by 12). The after-tax amount paid out will be R26 752 based on the marginal income tax tables.
If instead you decide not to consolidate your R5 000 000 pension and your R3 000 000 discretionary funds, does the picture change? Since the R5 000 000 makes up 63% of your total savings we will assume that this same proportion will be taken from the monthly drawdown (63% of R33 333) – that is, R20 999 before tax. A further R12 333 must then be taken from the discretionary money to arrive at R33 333 per month.
Your R20 999 before tax from your pension money would equate to R18 017 after tax. Meanwhile, capital in your discretionary investments is only liable for Capital Gains Tax at 10.40%, Dividend Tax at 20% (which is already paid by the investment firm) and interest tax at 26%. Remember though that you are entitled to a rebate of R40 000 each year on any capital gains made and R23 800 on interest earned before the age of 65. This means that, depending on the markets and the asset allocation of your funds, you should be able to withdraw your money at a much lower rate than your marginal income tax rate.
Your nett income would then be: R18 017 + R12 333 = R30 350, as opposed to R26 752 nett if you had consolidated everything into your pension money – a significant difference.
However, it should be noted that although there are numerous ways to structure and optimise your tax position, over time the nett effect will most probably be the same.