Question:
I'm 47 and about to withdraw my pension fund (its value will be R2-million after I pay 19 percent tax). I would like to receive an income of R13 000 per month, increasing with inflation.

Where can I invest to achieve my goals and do I have enough?

Answer:
When dealing with retirement funds, it is important to distinguish between withdrawal and retirement. These two scenarios hold different implications in terms of lump sums and taxation. A member of a pension fund may only withdraw from the fund upon termination of employment. This could be by means of resignation, retrenchment or dismissal.

When retiring from a fund, members are entitled to take up to a maximum of one third as a lump sum. The remaining two thirds must be used to purchase an income through a compulsory vehicle such as a living annuity or life annuity. The same does not hold true for withdrawals where a member has access to the full benefit (albeit at a more penal tax rate) and may choose freely where they wish to invest it.

Theoretically, this means that your options are without limit. This could include trying your hand at venture capital with a start-up business through to investment properties and even tank containers. But before we venture down the path less travelled, let’s consider some of the more conventional, tried and tested methods of investing for an income.

The two favoured vehicles for discretionary investments are endowments and unit trusts. To better discern the right vehicle for your own purposes, one should carefully consider two key areas that differentiate these vehicles, namely: taxation and liquidity.

Endowments are governed by the Long-Term Insurance Act and are therefore taxed within the investment by what is known as the 'four-fund approach'. The four funds refer to separate 'pools' for individuals, companies, corporates and those that are untaxed (public benefit organisations, churches, etc.) each of which are taxed differently. Assuming we are looking at an individual’s investment, then the taxation applicable will be a flat 30 percent tax on all net rental income (if there is property in the portfolio) and interest (accrued from fixed instruments). This then means that all capital gains will attract Capital Gains Tax (CGT) at a rate of 7.5 percent. This tax is paid within the fund and on behalf of the investor. The result is that the proceeds will be free of any tax purely because it has already been paid within the fund. The only exception to this is second-hand policies (where you are not the original beneficial owner) where CGT will also be payable by the investor on deemed disposal and on top of CGT already paid within the fund.

Collective investment schemes, (aka. unit trusts) on the other hand, are governed by the Collective Investment Schemes Act and all taxation is dealt with in the hands of the investor. Now before we discard this all together, one must look a little closer…

Although all income, interest and capital gains accrue directly to the investor, there is some benefit to this. Firstly, if your tax rate is under 30 percent then it becomes a 'no-brainer' as you will undoubtedly be in a better tax position. What is more, SARS allows for certain exemptions when it comes to interest and capital gains. For the tax year 2009/2010, the first R21 000 (under 65s) or R30 000 (over 65s) earned in interest is exempt from income tax. Similarly, capital gains up to R16 500 per annum are also exempt, however, it must be noted that a deemed disposal (selling/switching of units) must have taken place to benefit from this. So, just in the example of interest, one could easily have up to R300 000 (assuming you’re under 65 and earning seven percent per annum) invested in interest bearing instruments without attracting any income tax. Take this one step further, if interest bearing investments constitute only 30 percent of your portfolio (think balanced fund), you could have R1-million invested without any income tax payable. At a value of R2-million and assuming the above, only R21 000 would be regarded as gross income and liable for income tax.

The second consideration would be liquidity. Endowments have limited accessibility in the first five years (known as the restriction period) where an investor may only have two access points via one loan (usually interest free) and one surrender. This is also subject to a maximum of premiums plus five percent compounded, meaning that if your fund performed in excess of this amount one would be limited to a five percent compounded amount until the end of the five year period.

One could 'sidestep' this by means of second-hand policies that have already run past the restriction period but not without additional CGT consequences. These should therefore be approached with caution.

Collective Investment Schemes on the other hand have full and unlimited access and therefore make them a more suitable home for investors looking to draw regular income.

The decision on how best to invest this money to ensure 'it is enough' becomes a far more complex discussion and one best left to a one-on-one engagement with a Financial Planning Professional.

In essence, to receive an annual income of eight percent of capital, one would need to invest quite aggressively to ensure that one’s capital does not erode and keeps pace with inflation.

Considering the increasing life expectancy of people through medical advances, it would not be out of the question that you may live another 47 years. To get this one right will take very careful planning and thorough reviewing on a continual basis.

acsis Limited is an authorised financial services provider. The response to the question covers some of the issues in a general and factual manner and does not constitute advice. It is important to consult with a financial planner who, after an analysis of the individuals’ personal needs, goals and circumstances, will be able to provide comprehensive and appropriate advice.

If you would like acsis to put you in touch with an independent financial planner, click here!

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