I will be going on retirement shortly. I am with a bank and on their defined benefit pension fund. I am looking at the most tax effective way of investing the one-third lump sum above R500 000. I am considering a living annuity to supplement the monthly pension from the bank. Is this a good idea or are there other options? Also, which Shariah-compliant fund is safest with the highest growth?
Structuring the most efficient retirement portfolio is one of the most important decisions you will ever make. This not only includes ensuring you are choosing the optimal investment vehicles, but also ensuring your investment strategy is correct. The investment strategy at retirement is crucial, as you need to ensure your capital will last as long as possible. This is of particular importance when planning a retirement as statistics show people are living longer. Women also tend to outlive men by four to five years in South Africa. Therefore, your retirement income will need to last for perhaps another 30- or 40-year investment term after your reach retirement age.
Firstly, remember that you can access the first R500 000 at a 0% tax rate, but only if you have not made withdrawals or received a severance benefit before (since retirement benefits are aggregated for tax purposes). I do not advise drawing more than this component at retirement, as the withdrawal above R500 000 will be taxed. The R500 000 can be placed into an accessible investment and, depending on your income requirements, a monthly income can also be drawn from this investment. Or you may elect to use this investment as an emergency fund, or for any other unforeseen or additional monthly expenses that may be required.
The remainder of the funds (above R500 000) can be reinvested into a living annuity, as you mentioned.
I prefer a living annuity (as opposed to a life annuity at retirement) for a few reasons.
- You can nominate beneficiaries, so should anything happen to you, your loved ones will take over the investment income.
- You have the benefit of having exposure to the market. If you diversify your portfolio correctly, you will benefit from higher returns.
You can be protected against the downside of market cycles by optimal diversification and active management by your advisor.
Selecting an appropriate investment strategy within a living annuity will be important to ensure you are planning for longevity. If you are drawing too high an income percentage, or if the investment’s asset allocation is not yielding a return high enough to accommodate inflation and income withdrawals, you can deplete/outlive your funds.
Shariah-compliant funds are still quite limited in our country. The benefit of reaching the retirement stage, and moving your retirement funds to a living annuity, is that Regulation 28 of the Pension Funds Act no longer applies. Regulation 28 limits you in the pre-retirement stage with regard to your offshore and equity exposure. Depending on your risk capacity and tolerance, this may be beneficial within a living annuity and a voluntary investment as you can hold more equity exposure as well as more offshore exposure within your portfolio. This can assist in increasing returns, but may also increase the volatility experienced by your investments.
Shariah law prohibits investment in many of the equities typically included in unit trust portfolios as these funds are strictly managed in accordance with Shari’ah (Islamic Law) and therefore do not invest in shares of companies whose core business involves dealing in non-Halaal foodstuffs or interest-bearing instruments.
There are a few Shariah-compliant funds to consider, and the correct balance between equity funds and your risk appetite is therefore important.
Combining an income-based portfolio (consisting of Islamic bonds) for your income withdrawals and shorter-term needs, together with equity portfolios for the longer-term capital growth, is the optimal strategy. A balanced approach can also be included between the income and the capital growth strategy.
A retirement strategy could possibly look like this:
The returns on the Old Mutual Albaraka Income fund (for income requirements in the first 2-3 years):
The returns on the Old Mutual Albaraka Balanced fund (for income requirements in year 3-6 of retirement):
Lastly, the Old Mutual Albaraka Equity fund (for income requirements 6 years and onwards into retirement):
I specifically refer to Old Mutual’s Albaraka funds in this article. There are, however, other appropriate Shariah-compliant funds that can be used in the investment strategy.
I would advise speaking to a wealth advisor to structure the optimal retirement strategy for you. Annual rebalances will be done to ensure the original strategy is maintained, ensuring low-risk income requirements are met, but also ensuring sufficient equity exposure is structured for long-term capital growth.