I am now 56 and I would like to retire when I turn 57 in late December. My company pension fund will provide me with an annuity of about R20 000 (after tax). I have no debts. My investments are about R4 million and my other retirement annuities are around R2 million. My current expenses are around R20 000 per month. But I would like about R50 000 after tax per month as I might need to travel. My questions are: which companies offer the best annuity? What should I ask for and look out for when purchasing an annuity and what costs could I expect to pay? If I draw down 4% do I need to increase this drawdown annually to account for inflation?
Thank you for your question. We are assuming that your company fund is a pension fund and not a provident fund and that you have not retired from any of your retirement savings yet. In answering your question, we have taken into account the following:
Life annuity vs living annuity
In choosing an annuity, you have the option to choose between a life or a living annuity. A living annuity would be invested in the market and subject to an annual drawdown between 2,5% and 17,5% per year. Your fund value would fluctuate depending on how the underlying funds perform. A life annuity is where you purchase a guaranteed income from a service provider where you have no market risk and the service provider pays you a monthly income for the remainder of your life.
To answer your question more fully, we have researched what after-tax monthly income you could purchase with R6 million, assuming that your income increases annually in line with CPI (consumer price index). Our research shows that you should be able to purchase a life annuity that would provide you with an approximate after-tax income of R24 000 per month. However, considering your need for capital expenditure in retirement, we have assumed that you would prefer to make use of a living annuity structure. When choosing a living annuity, you will need to consider the following:
Liquidity in your retirement portfolio would be the first matter to consider. When you retire from both your pension fund and your retirement annuity, you have the option to take up to one-third of the funds in cash, while the remaining two-thirds must be used to purchase a living or life annuity. Any portion taken in cash will be subject to the retirement tax tables. Should you take the full one-third as a cash lump sum, being R2 million, you would pay tax of approximately R477 000. Keep in mind, however, that the first R500 000 withdrawal is tax-free so we would definitely recommend taking out this portion. Thereafter, depending on your capital needs in retirement and your need for emergency funding, it might make sense to pay a bit of tax by drawing more in order to create liquidity in retirement.
The alternative to this would be to use your full R6 million to purchase a living annuity, although this would mean that you would be subject to the living annuity drawdown rules where you can only draw between 2,5 and 17,5% of the fund value per annum. While this might not result in liquidity issues early on in your retirement, it may cause liquidity issues later on.
It would be advisable to make use of a unit trust-based living annuity structure where fees and costs are transparent. Depending on whether you have a financial advisor or not, the fees you can expect to pay would be an administration fee, investment management fee and financial advisor fee.
Underlying investment choice
Provided you are not taking out an in-fund living annuity, your living annuity would no longer be subject to Regulation 28 of the Pension Funds Act. This means you will have a lot more flexibility in fund choice and asset allocation when tailoring your portfolio. It is, however, always advisable to speak to your financial advisor when making such a decision.
When choosing a living annuity structure, keep in mind that your drawdown will need to change as the general cost of living increases. Each year, at the anniversary, you will have an option to amend your drawdown on your living annuity. Since these drawings are taxable, it is advisable to work with your financial advisor to select a drawdown level that is most appropriate to your needs. An option worth considering in this regard is to withdraw a portion of your capital at retirement and to reinvest these proceeds into a discretionary investment. These funds can then be used to supplement your living annuity drawdowns and to help reduce your tax liability. Bear in mind that, once the funds in your discretionary investment are depleted, you are not able to make an ad hoc withdrawal from your living annuity.
Estimated retirement plan
Doing a rough estimation of your retirement plan, we have assumed that your retirement savings would be R6 million at the date of retirement. Assuming you allocate R1 million for travel expenditure, you would need to draw out R1.2 million from your retirement savings. Applying the retirement tax table, you would pay approximately R200 000 in tax, leaving with R1 million to invest in an inflation plus 4.5% per year discretionary investment which you could allocate towards your travel expenses.
We have assumed that the remaining R4.8 million would be invested in a living annuity which targets returns of inflation plus 4.5% per year net of all fees. Assuming you draw an income of R20 000 per month from this investment, increasing annually in line with inflation, your capital would be depleted by age 90.
Keep in mind, however, that there are a number of moving parts in a retirement plan and our experience shows that changing circumstances can affect your plan. It is highly recommended that you consult your financial advisor before starting your retirement journey.