Question:
I am 66 years old. My wife and I have two properties (fully paid) and R2-million in investments with Liberty Life, part of which is a retirement or pension fund.

We are still working, but would like to slow down and start enjoying a quieter lifestyle.

Rent from one property is R7500 per month and we live in the other one. We were thinking of placing about R800 000 in the money market with Absa which would give us 11.2 percent on a monthly basis. We'll leave the rest as an annuity which we could access later as we need it.

Do you think this is a good idea? Or should we make the pension/retirement fund paid up and start drawing on that?

Answer:
There are a number of key questions you will need to consider over the next few years. They all boil down to the best way to fund your retirement lifestyle and how your wealth can be used to sustain your needs as securely as possible for as long as possible.

As far as the question of your income is concerned, we need to consider the following:

  • The rental income you are currently receiving is taxable in your own hands. If your wife has no substantial income going into retirement (including her annuities and pensions), it would make sense for you to transfer the income to her. There are, however, a number of specific questions that you would need to answer before you can ascertain how this can best be done. As this information is not available to me, I would urge you to consider this question with a properly qualified financial planner — preferably a Certified Financial Planner (CFP).

  • When you retire from your retirement annuities and pension fund, the annuity income you earn from this will be taxable in your hands. As a lump sum, you can take up to a third of the balance in cash (or all if you have a provident fund) and invest the rest into a compulsory annuity to provide a taxable income in retirement. As a lump sum, it would make sense to consider taking the tax-free portion of these investments and a part of the taxable portion until your effective tax rate roughly measures up to the average income tax rate you will pay once you start receiving your annuity. By looking at the specific numbers in your case, a qualified financial planner would be able to help you understand where the ‘sweet spot’ for this will be.

  • Although interest rates are currently high, it is important to remember that the interest you earn that exceeds your annual exemption (currently R27 500 for those older than 65 and R19 000 for those under) will be taxed as an income. Although R800 000 is little enough to allow you not to pay any tax, this will become a problem if you are earning any other forms of income (annuity incomes, rental income, etc.).

  • By investing a large portion of your money in cash, you give your capital very little chance to keep pace with inflation over time. Even if you draw only the interest you earn, the effect of inflation (at an average of about six percent) will halve the real value of your income roughly every twelve years. This means that the estimated R7500 (which will decrease as interest rates go down) interest you’d earn each month on your R800 000 will be worth R3750 in today’s terms when you’re 78. By the time you’re 90, you will be on R1875. Past the age of a hundred, you’re looking at less than R1000 per month! So if you want to sustain your lifestyle, cash will probably not get you there.

  • If your total investment portfolio gives you a return matching inflation (as cash might do if you’re lucky) and you live to the age of 100, your R2-million investment will be able to provide you with a pre-tax income of only R2500 per month (increasing with inflation). If, however, you are prepared to take some risk (a moderate portfolio providing, say, three percent growth above inflation), this income will go up to R4000. If your R7500 rental income escalates in line with inflation, your total income will come to about R11 500 before tax.

From the above, I would suggest the following course of action:

  1. Make sure that you minimise your joint tax liability (between you and your wife) by seeing a financial planner who will advise you how to do this.

  2. Reconsider before you invest a large chunk of your portfolio in cash. You will end up paying more tax and will drastically limit the amount of income you can draw over time.

  3. If your needs are currently in excess of the rental income you are receiving, it would make sense to start drawing from your investments. If you retire from your retirement funds and start drawing an income, you will pay less income tax on average over time because your average taxable income will be lower over the term of your retirement (it will be smoothly supplemented by capital withdrawals from your discretionary investments).

  4. Speak to a Certified Financial Planner to gain a proper understanding on the most tax efficient solution for you.

  5. Consider the impact that more aggressive investment strategies will have on your income needs over time, and settle on a strategy that will provide you with the most growth you can get at a level of risk you are comfortable with.

By using the above as a guide, you should have a good start to finding the balance between growth, risk and tax efficiency, which are key issues when going into retirement.

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