How much do I need to invest to have a monthly income that is below the tax threshold, if any? I’m a 64-year-old male, with no underlying illnesses. The investment term will be 10 years. What is the capital investment amount and the expected monthly income?
Your question does not clearly state where the funds are coming from, so I am making a few assumptions. I am assuming you have already planned and saved for retirement at the age of 64 and that you want to purchase an annuity from which you will earn an income. I am assuming that your funds are most likely coming from a retirement product (pension fund, provident fund or retirement annuity). Lastly, you do not specify why there is a 10-year term to this investment, and whether you are aiming to deplete your capital, or if it should remain available at the end of the term. Since the life expectancy of a healthy 64-year-old man may be longer than ten years, I have assumed you want your capital to remain available at the end of the term.
At 64, the income tax threshold is R83 100 (for the 2021 tax year), equating to a monthly income of R6 925. If we assume investment into a living annuity and work on a 5% withdrawal to provide you with your annual income of R83 100 p.a., the capital amount initially required will be roughly R1 660 000. However, you should note that the tax threshold changes to R128 650 at 65 years of age, which may influence your investment decision.
It should also be noted that for tax purposes, your various sources of income may be aggregated and the total tax liability is based on the total income earned. Since the drawdown rate on a living annuity can be adjusted annually, you will be able to take a higher income in line with the tax threshold at 65 years of age into account. However, you should consider if the selected drawdown rate is sustainable in the long run.
Looking at the retirement approach we follow at PSG Wealth R21 and how we construct portfolios for retirement, our advice is that you should not draw more than 5% of your fund value, to ensure the capital will not be depleted too soon. You need to consider your income needs, together with inflation and income withdrawal. The investment strategy you follow will determine the outcome your investment achieves.
It is important to remember that most investments are dependent on market factors, and therefore returns may vary from year to year. Over time, your income withdrawal will also start to deplete the capital value, and at that time your annual 5% withdrawal will of course be worth less.
The opposite is also true. Depending on the investment strategy that was followed and the market conditions, your capital may enjoy a positive return in the first few years, so even when drawing a monthly income your capital will not yet be touched. This is very positive, as we need to take into account that inflation plays a big role.
In SA, the largest expense most retirees need to plan for is their medical aid, which can equate to up to one-third of the average income at retirement. Real medical inflation is closer to 8% to 10% in the longer term, and your planning should take this into account.
When planning for return vs income withdrawal at retirement, the Asisa-provided living annuity drawdown table can provide a good guideline to understand the impact of time, income withdrawal and annual return on your investment. It outlines the different outcomes given different drawdown rates ranging between the allowed minimum of 2.5% and a maximum of 17.5% of investment value per annum. Increasing your income (or earning a lower return for a few years) can take years away from the longevity of your investment.
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If the source of your funds is not from a retirement product, i.e. if these are currently voluntary funds, then the tax implications will be different. Firstly the funds are more accessible – and can therefore be reinvested into a more flexible investment. The principle of withdrawing 5% of fund value will remain the same (assuming you want to preserve the capital as long as possible), but the possible tax implications will be different.
For example, there will be tax on interest earned, as well as possible capital gains tax (either with a withdrawal or a rebalance of the equity components). However, you will be able to use your individual annual tax exemptions. On interest income earned, this will be R23 800 per annum for persons under the age of 65 and R34 500 for persons 65 years and older. An individual also has a R40 000 per annum exclusion on any capital gains made. Your annual CGT liability can be managed by following the investment approach where small rebalances will be made on an annual basis so that tax implications are kept at a minimum as far as possible.
Structuring your retirement is one of the most important decisions you will ever make. Finding the solution between earning a secure income, but also ensuring your capital will last as long as possible, requires a delicate balance. I recommend speaking to a wealth advisor about how to structure your retirement journey based on your goals and objectives.
First, some background. All investors are liable for tax when they earn money on their investments in the form of interest, dividends or capital gains. The amount of tax that investors have to pay depends on age, applicable rebates, marginal income tax rate, the type and amount of investment income and capital gains earned.
In the 2022 tax year, income earners (either via salaries/ earnings or via investments or interest earned) under the age of 65 start paying tax when their income breaches R87 300, over 65s start paying tax at R135 150 and those who are 75 and older start paying tax at R151 100.
Over and above the primary, secondary and tertiary age-related rebates described above, interest earned from ‘fixed interest investments’ such as bonds, interest-bearing unit trusts and/or cash in the bank is subject to income tax and is taxed at your marginal tax rate. Dividends received by investors in South African companies are generally taxed at a rate of 20% and paid directly by the companies concerned to Sars, so there are no further administrative tax obligations.
Individual taxpayers are eligible for an annual exemption on South African interest income they earn. For both the 2021 and 2022 tax years, this rate of interest exemption has been set at R23 800 for individuals under 65 years old, and R34 500 for individuals 65 years and older. If you earn more than the exempted interest income in one year, you will be taxed on the difference and taxed according to your tax bracket. Note that any interest from the money in your medical savings account of your medical scheme is also liable for tax.
This means that if you are 66 and earn R140 000, R40 000 of which is interest (and you have no accumulated interest in your medical savings account), you will pay tax at the 18% level. You will be eligible for an interest rate rebate of R34 400 and the balance (R600) will be taxable at 18%.
To answer the reader’s question, we have had to make a few assumptions.
- We have assumed that the reader would like the capital to be intact at the end of the year and it should therefore be invested in lower-risk investments.
- We have assumed that no interest is payable on a medical savings account.
- The reader should be aware of the fact that the tax threshold for interest changes when he/she turns 65.
The following table offers a guide on the amount of capital that would be necessary to earn R23 800/R34 500 at different interest rates. Costs of investing have not been taken into account.
|Capital required||Interest rate||Tax threshold for U65s||Capital required||Interest rate||Tax threshold 65 and older|
|R1 190 000||2%||R23 800||R1 725 000||2%||R34 500|
|R476 000||5%||R23 800||R690 000||5%||R34 500|
|R297 500||8%||R23 800||R431 250||8%||R34 500|
|R238 000||10%||R23 800||R345 000||10%||R34 500|
An investor requiring a fixed interest investment has a number of choices. An important aspect to take into account is that interest earned in fixed interest investments should outperform inflation. Statistics South Africa expects that the current inflation rate of about 3.34% to rise to 4.5% as we get closer to 2025. To earn above-inflation interest, investors should currently aim for an interest rate of above 3.5%, but expect that in the future, a higher interest rate will be required. For more on this, click here.
- Investing with retail banks in fixed deposits
Banks offer a sliding scale of interest rates, depending on the length of time the money is invested, whether interest is payable annually, semi-annually or at the end of the investment term, and of course how much money you invest. Rateweb, a South African website offers a comparison of interest rates which can be viewed by clicking here.
- Investing in RSA Retail Bonds
A second option would be to invest in RSA Retail Bonds. These come in two types; fixed-rate bonds and inflation-linked bonds. You can also choose to invest for either a two-year period, a three-year period or a five-year period. RSA Retail Bonds are currently offering a fixed rate return of 7.25% a year, or an inflation-linked rate (inflation plus 4.75%) for a period of five years. For more on this see here.
- Investing in fixed interest unit trusts
Investors who require low-risk investments but don’t know how to choose between bonds, the money market and similar investments, can opt for interest-bearing unit trusts. Interest bearing funds are those that invest exclusively in bond, money market investments and other interest-earning securities. There are three types of interest-bearing unit trusts; 1) Interest Bearing – Variable Term, 2) Interest Bearing – Short Term and 3) Interest-Bearing – Money Market.
The first type, Interest Bearing – Variable Term invest in a combination of relatively longer-dated securities as well as real estate securities and preference shares, and will change over time to reflect the manager’s assessment of interest rate trends. Leading asset management companies in this sector have produced annualized returns of just over 10% over the last five years, excluding payable fees.
The second type, Interest Bearing – Short Term portfolios also invest in bonds, fixed deposits and other interest-earning securities, but the weighted average modified duration of the underlying assets is limited to a maximum of two years. The best performing portfolios in this sector have produced returns between 8.5% and 8.9% annualised over the last five years, excluding fees.
The third type, Interest Bearing – Money market portfolios invest in money market instruments with a maturity of less than 13 months. The average duration of the underlying assets may not exceed 90 days and a weighted average legal maturity of 120 days. Top-performing portfolios in this sector have produced average annualised ranging from 7.33% to 7.44% over the last five years, excluding fees.
It is unusual for banks to advertise fixed deposit rates for periods of ten years, as required by the reader, and the maximum period available for SA Retail Bond investments is five years. There are no set terms for investors in fixed interest unit trust; investors are free to buy and sell to suits themselves.
Monthly income earned in interest varies depending on the amount of capital invested, the term of the investment, the nature and quality of underlying holdings and the degree of flexibility afforded to the asset manager.
While interest-bearing funds are considered to be safe investments, it is possible for investors to lose their capital. Some of African Bank’s investors suffered capital losses in 2016, which had created a ripple effect in interest-bearing portfolios of other financial institutions.
Rosebank Wealth Group has developed good relationships with fund managers of interest-bearing investments and the company is well-positioned to advise clients in this regard.