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Are my pension plans wise?

After taking out my pension to pay off my bond, I want to invest the rest in an annuity for life once fully retired.

I’m considering taking out my pension (around R900 000) to pay my outstanding bond (R200 000) with the one-third portion and investing the other two thirds in a living annuity with a drawdown rate of 2.5%. I am 62 and am working on contract until the end of this year. I will then be able to save the payments I am currently making on my bond ­– possibly in a tax-free savings account – and then, when retired fully, will have some savings capital for a rainy day.

I want to invest my two-thirds into a living annuity with the lowest drawdown rate of 2.5% for now, while working. I will convert it into an income for life once fully retired as the life expectancy on my mom’s side of the family is 85. Will there be any costs for transferring it?

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I would agree with your decision about wanting to settle your bond. In our opinion it’s important not to have any debt worries when you officially retire.

With regards to the plan you have laid out, there are a few key points you may not have taken into consideration that I would like to highlight as important.

1. Retiring and retirement age

When retiring from a pension or retirement savings plan it is important to know the actual product that you are retiring from. This is important because if you are retiring from a company pension or provident fund, the company fund rules will advise what the retirement age is for employees. If the product you are retiring from is a retirement annuity (RA) or a preservation fund, you can retire from age 55, and can then convert these investments into a life or living annuity to draw an income for retirement from. Please also note that a pension fund and provident fund are different and have completely different rules at retirement. The breakdown you have provided is going by the rules of a pension fund.

2. One-third allowable cash portion

The maximum allowable cash portion you can withdraw is one-third, with the remaining two-thirds required to go into either a life or living annuity. The cash portion that you withdraw is taxable, but you can draw up to R500 000 tax-free. Please be advised that any previous retirement withdraws, be it pre- or post-retirement, will affect the tax-free portion amount at retirement. When Sars receives the notification of the withdrawal, any taxes owed to Sars will be deducted from the cash portion before it is paid over.

If you are just drawing the cash value of R200 000, which is your outstanding bond amount, this should not be taxable as it is below the tax-free limit of R500 000 – that is if you have not drawn previously from a retirement saving and have not received any severance package.

3. Living annuity vs life annuity

You have mentioned that you would like to convert your living annuity to a life annuity when you officially retire. This option would be entirely up to you. We would like to highlight some of the important differences that we consider when  assisting clients in making an informed decision.

Living annuity

  • You can draw an income of between 2.5% and 17.5% per annum (income change can only be done on the anniversary date of the investment).
  • You can nominate beneficiaries so that on your death this will be paid to your beneficiaries and does not form part of your estate.
  • You can select which funds you would like to be invested in and can have offshore exposure, as there are no regulation limits attached.
  • Among the providers we have dealt with, there have been no fees charged to transfer to a life annuity, but this may depend on the investment company selected.

Life annuity

  • The investment company will determine the income you will receive.
  • You are unable to select beneficiaries, which could be a disadvantage if you were to pass away early in retirement.
  • No changes can be actioned in a life annuity once it is initiated (you cannot make changes in terms of the income you are receiving or convert it back to a living annuity).
  • You are able to add guarantees to these investments, but this then can come at an extra cost and so potentially decrease the income you will receive.

Life annuities have changed recently with certain benefits added on, but should you still wish to convert when the time comes, it would be advisable to discuss this with an advisor who can analyse the differences and advise according to your needs and requirements.

4. Tax-free savings

Investing your bond payments into a tax-free savings account (TFSA) is a great idea. Please just be aware of the limits and restrictions in terms of contributions made to these investments.

The limits are:

  • A maximum contribution of R33 000 per year
  • A maximum monthly debit order of R2 750
  • A lifetime limit of R500 000

Please ensure that later, when investing the money that would have gone into bond payments into a TFSA, it does not exceed the monthly maximum debit order value (R2 750), as Sars will charge a penalty.

In terms of additional advice – should you not require the income you are drawing from your living annuity while you are still working, you could consider investing it in a well-managed unit trust investment. This is a liquid type of investment, so if you require additional funds once you have retired, you will be able to make a regular withdrawal or even withdraw the full value invested.

There are many things to consider and we do recommend that you contact a financial advisor who will compile a proper financial planning analysis and provide you with the most appropriate solution to meet your requirements.

Disclaimer: Please note that the above has been drafted purely on the scenario provided by this reader and our recommendations herein are based on the circumstances provided and should not be construed as complete and comprehensive investment-planning advice.

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