My mother recently retired and will be receiving her provident fund. Her lump sum will be about R400 000, which is not much as this will be her only source of income besides the old-age pension from the government. What would be the best way for her to invest her money, where she would receive a monthly income from it without the risk of losing it?
Structuring a retirement income product is one of the most important investment decisions we need to make in our lives. When retiring at 65, for example, this is only the start of another 20- to 30-year investment term. At retirement there are a few important decisions that will need to be made:
- Selecting the appropriate investment product. As there are different tax implications with different products, as well as differences in accessibility, finding a suitable product for your individual needs is imperative. I advise speaking to a financial advisor to make an informed decision.
- Determining the monthly financial need and income drawing percentage.
- Choosing an investment strategy and underlying funds.
Firstly, the type of investment product will need to be selected. To make this decision, the source and the fund value of the investment need to be taken into account, as well as the tax table that is used at retirement:
You do not say whether your mother has previously made a withdrawal from a retirement fund. At retirement (from the age of 55 years), the first R500 000 will be tax-free upon withdrawal, and after that, the sliding scale will apply.
The investment product that is most often used at retirement is a living annuity.
An annual income of 2.5% to 17.5% of the fund value needs to be selected – and this income can only be amended annually on the anniversary date. The income received will still be taxable, and you are allowed to nominate beneficiaries on this investment should something happen to you.
The fact that she is invested in a provident fund and the value is below the R500 000 tax-free threshold, makes it possible to withdraw all the funds, and to invest the funds back into a voluntary (accessible) investment – this option will provide more flexibility as the income withdrawal can be amended throughout the investment term.
The second important aspect will be to select which income percentage will be drawn. This is probably the most important decision, as drawing too high a percentage will deplete the capital too quickly.
Even a very well-performing investment will not be able to outperform a higher-than-advised income withdrawal. Taking inflation into account as well as the performance of the investment, it is important to ensure that your drawdown rate will not erode your capital too quickly.
The table below explains the effect of income withdrawal when taking different investment returns into account. For example, drawing an income of 5% annually with an investment return of 10% will ensure that the capital will last for 33 years.
If that withdrawal percentage is however increased to 7.5%, the number of years for which an income can be sustained decreases to 13.
Lastly, selecting an appropriate, well-diversified investment strategy will be very important. With any income-generating investment, it is important to find the correct balance between low-risk short-term structured funds, and longer-term growth assets that will ensure the capital is still earning an above-inflation return.