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Can I cash out my pension to invest?

Reader’s question answered.

Q: I am considering resigning from my job. l have worked for 22 years and under a pension fund scheme. l am 46 years’ old and expect to get slightly over R500 000. Is it is possible to invest in a vehicle that will pay out at an income of at least R15 000 per month?

A: Now, I don’t know your specific situation. I’ll just assume you require the income to sustain you whilst looking for an alternative, more fulfilling employment opportunity. I simply raise this because proper advice requires proper disclosure of information. Information forms the basis of financial planning and thus my answer below may be compromised in its ability to answer the question of “What should you do?”. 

Should you willingly opt for resignation as opposed to retirement?

To some, it may seem to be rehashing an old topic, but it looks like many people out there still don’t understand the difference, not just from a tax perspective, between “resignation” and “retirement” – especially as far as their pension funds are concerned. 

When making the decision to resign you’re essentially taking onboard the responsibility of balancing the risk of investment returns vs potential income. Why is this important? Because with any investment account your number one enemy is inflation. If inflation is the biggest threat to your retirement plan, then being in a separately-managed annuity or investment account can pose a few challenges. The biggest of these is that to overcome inflation over an extended period, you would need to make use of investment assets that can overcome this risk, such as listed property and equity. This, however, introduces an additional element of volatility risk, which can cause the invested capital value to fluctuate. If you accept this point, then you could go on to argue that there is no way of escaping capital risk if you want a high and sustainable return to fund your income. 

Drawing an income from an investment requires some form of stability and certainty in investment returns. The problem is when you build stability and certainty into an investment account, you decrease the potential risk and with it, the potential return. It’s a catch-22 as you will be required to take on additional risk in order to try obtain the necessary returns to sustain your income, while not depreciating your invested capital. 

Consider tax implications

From a tax perspective, it’s important to understand the difference between “retirement” and “resignation” since the difference in the amount of tax paid is vast – especially when it comes to lump sum payments from a pension fund. As far as Sars is concerned, “retirement” is when you leave the employ of your company, normally with the intention of not working again. This can happen any time from your 55th birthday or at any age if your health or a disability dictates that you are no longer able to work.  

On the other hand, “resigning” from employment is a different matter, especially if you decide to take your accumulated pension in cash. In this case, there is no external event beyond the individual’s control (reaching a certain age, suffering ill-health, or becoming disabled) that prompts the person to leave their employ. Given that the ideal for Sars would be for you to preserve your accumulated pension funds until normal retirement age, Sars imposes punitive tax rates aimed at discouraging resigning employees from taking their cash; failing which, such taxation is aimed at enabling Sars to recover the tax foregone by means of the relief granted on the contributions to such retirement savings. 

How best should I generate this income?

Investing is never an easy task. It’s made even more complicated when an investor introduces the added obligation of generating a steady income off their investments.

One way is to build an alternative dividend income portfolio. Dividends are the portion of a company’s profits that is paid to shareholders, usually twice a year on a per share basis (that is, you get a certain amount of money for each share you own). Typically, investors reinvest their dividends, but since you’re looking for income, you would take the distributed dividend income out and use it to pay your living expenses. Dividend-yielding stocks offer you the potential for capital growth (if the share prices of the underlying shares rise), and for inflation-beating income. Dividends are currently taxed at 20%, which may be lower than your income tax rate, depending on how much you earn, so this asset could have tax advantages for you. On the downside, there is no guarantee that you will earn any income from a dividend-yielding stock portfolio (although it is likely), and you will risk losing your capital if the value of your shares fall.
 
When it comes to investing in dividend stocks, investors have a lot of options. They can invest in companies that are already paying a high yield or buy shares of stocks that are currently paying a low dividend with the hopes that it will increase in the future. They can diversify their risk and income by selecting shares that pay dividends at different times of the year. One approach could be to look first toward funds with the longest track records for increasing their dividends year in, year out. The next step is to look at the months each investment trust pays dividends. Dividends have long been a favourite way for yield-seeking investors to generate income. 

In the current environment, I would suggest investors may want to focus on those dividends-paying companies that are going to be able to weather the storm. They may not pay the highest yield, but they also are likely to maintain and increase their payout. And while investors may be drawn to those double-digit dividends-paying shares, they have to be careful when making their investment choices, particularly in an environment marked by slow economic growth. After all, the dividend is only as good as the company that can afford to pay it. 

Look for companies that have enough cash flow to sustain their dividend, have consistently raised it and have signalled they will continue to boost it on a regular basis. Investors who go with a diversified portfolio that includes a mix of different dividend-paying stocks across a broad array of industries, will be better able to ride out the storm than investing in a single-dividend paying stock or a fund focused in only one area.

This is just one of many strategies one can employ. Consult with a wealth manager for a broader, more detailed answer. Or the more affordable option is to put your money into the Satrix Dividend ETF, which tracks the JSE Dividend Plus Index. The index is made up of JSE stocks that have a high dividend yield based on a one-year forecast, and because it’s an ETF, your costs are low.

Will my capital be enough to provide me with a sustainable income?

Can R500 000 provide you with a sustainable income of R15 000 per month? The answer is, no. 
Firstly, the stated amount of R500 000 is most probably a pretax amount meaning, should you resign, you’re realistically looking at a tax penalty of 18% on your capital. I’ll assume you haven’t used up your once per lifetime tax allocation of R25 000. If that is so, it would mean you would pay 18% (R85 500) tax on R475 000, leaving you with a net capital amount of R389 500.

Secondly, there’s a lot that goes into what determines your investment return. For the sake of time, let’s just assume you are able to generate an investment return of 10% (R38 950) in the first year of your investment. This would leave you with a total amount of R428 450. If you draw a monthly income of R15 000, that’s an annual amount of R180 000. This means that now you’re left with R248, 450. Not to mention fees involved or if you get a negative investment return.

It is at this stage that it should be quite clear that you’ll deplete all your capital within the following 18 months or so. Hence my original short answer of no. Unless, of course, you only require an income for two years or so and have other means to sustain you. I hope this has been of some help.

Mduduzi Luthuli is head of wealth management at Luthuli Capital. 

 

If you have a question that you’d like to submit to one of the advisors listed on Moneyweb’s Click-an-Advisor section, please contact eleanor@moneyweb.co.za

ADVISOR PROFILE

Mduduzi Luthuli

Luthuli Capital (Pty) Ltd

COMMENTS   16

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A general rule of thumb is that each million Rand will give you about a sustainable R4000 to R5000 income per month. So R500 000 will can give you R2000 to R2500 per month.

To the reader, I suggest you continue working until you have about R4 million saved up in that pension fund…

The short answer to the reader’s question, “Is it is possible to invest in a vehicle that will pay out at an income of at least R15 000 per month?” is YES, it is possible.

Invest the money in your bank account. Using a 32-day notice deposit earnings around 6% interest per annum, the money should last for 3 years before you have depleted all funds and are left without further income or capital.

Change your bank – you could get above 7% from most banks on 32 days.
Further I think the person asking the question was not looking at capital erosion so your suggestion is not helpful

Except the money that you pay out of the investment is not R15,000 in income because most of the funds would be from capital.

If someone has promised that you can earn R15k interest pm on R500k investment capital…it implies a return of 36% interest pa. I suggest you RUN AWAY!!! You are gonna lose every cent of your money because you are being scammed!

The crazy thing about this article is that the 46 year old reader is even comtemplating resigning.I sincerely hope he’s got another job lined up because he might think that 500k is a lot of money but at best it’ll tide him over for 2-3 years!

You’d be amazed by how a large number people can’t get a handle of large numbers that nonetheless valueless in currency.
E.g A million rand sounds which sounds like a lot of money, not to mention the long-held dream and constant banter to “make a million” which was worthwhile a long time ago.

Still remember the Liberty sales person quoting me telephone numbers as to what my policy would be worth in 30 years time, back in the 1980’s.I wonder what the 25 year old of today must be quoted!

One possible way right now to generate R15000 on R500000 (3% pm) is to maybe buy and sell Bitcoin on a trading platform, if you have no other source of income to sustain you. The returns may be erratic, but I have personally been trading quite BADLY (buying high, selling higher!) and still achieve an average above 5% return per month per trade. As for the risk factor, it has the ‘built-in’ safety net of holding onto for a longer term, in case you do struggle to make short term gains. Another idea: Spreadtrading – trade your own derivatives portfolio with a handful of stocks on margin with someone like GT247.com (they are local). Make sure of course that strict risk management is adhered to and EXPOSE ONLY SMALL AMOUNTS OF YOUR CAPITAL! Remember, ALL managed funds (unit trusts, ETF’s, hedge funds and yes all those decrepit RETIREMENT PRODUCTS are only there to fee your capital to death – they don’t care about improving your financial situation, only increasing their commissions and tying you in for life…and they cannot perform in adverse market conditions! They tell you to wait 5 years before expecting some level of performance…that’s like applying for a job and telling your employer you may deliver some work to him in 5 years!?

Bitcoins value is only determined by what others are willing to pay for it, believing that it price could only go one is very naive, you just need to look back to 2015 when bitcoin lost more than 50% of its value. While it has recovered the same cannot be said for the future. Especially if it happens to fork and you end up on the incorrect side.
https://www.moneyweb.co.za/news/tech/bitcoin-miners-signal-revolt-amid-sluggish-blockchain/

So I would not place to much value on the “built-in” safety net,

As for derivatives trading (as similar items such as binary option), in my opinion it is extremely dangerous for the average person to trade as they are very likely to lose their capital with the kind of leverage on those products.

Yes, I agree.
When trading BTC however, one would never put all your account money down on one trade; if it falls, you then buy more. They are punting it at around $3000 by year end, but I don’t even need anywhere near that. The currency is highly entrenched, so I don’t think it’s going away anytime soon!
With derivatives, I would not include Binaries as these are serious gambling instruments and there is no real way of determining an outcome until the end. (By the way, even here I have personally had some success on a demo account, but you need to maintain at least a 55% ‘strike rate’ for sustainable growth.
Yes, derivatives are dangerous, that’s why I mentioned STRICT RISK MANAGEMENT. They also happen to be the only way to protect yourself in falling markets, which effectively means you don’t really have to invest in anything else…ever! They also have the best potential return profile. Dividends certainly won’t get you anything, especially after our wonderful Finance Minister raised the DWT rate as mentioned above.

Point of correction. Should there be a split in the Bitcoin chain, you will just have both coins 🙂 Doesn’t matter which chain dominates- they’ll both have value. The exact same thing happened to Ethereum when it split. Everyone got the same holding in both ETH and ETC. Both ETH and ETC have high trade volumes and continue to compete just fine. The exact same thing would happen should Bitcoin split. There’s nothing to be concerned about. The developers have also upgraded the code to include “wipeout” protection of the main chain. Bitcoin can quite simply- never die. It’s hellishly resilient in overcoming whatever problems are thrown its way.

Obviously, quitting your job at 46 is assumed to be a crazy move. But people all have unique life situations (debt levels, income requirements and ability to produce income without working for it). Inflation (especially medical inflation) will remain the big killer! Even income tax is not as bad, since there are still ways to AVOID excessive tax by structuring various income sources wisely.
Unless you can kill inflation and tax, you will struggle. You need at least 15% if not 20% return pa…and you may have to live like a bum for a while!

“there are still ways to AVOID excessive tax by structuring various income sources wisely”

Anything that will withstand public scrutiny ?

This article is a very elaborate way of saying “Generally, no; possible but extremely difficult, risky and unlikely.”

It’s one of those “Don’t try this at home” cases.

A suitable vehicle might be a taxi, but it’s not for everyone.

I recommend the reader gets his next job lined up before he resigns, and preserves his fund.

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