Monthly Archives: June 2017

Advice for withdraw your retirement benefit

In this advice column Beata Carstens from Veritas Wealth answers a question from a reader who is thinking of withdrawing his pension.

Q: I am 39 years old and have worked for the public service for just over 11 years. I am considering resigning because I want to further my studies for the next three years.

My current retirement fund value is R947 113.

How much will they tax me if I take this out and how best can I invest it?

The short answer to your question is that you will be paying R191 820.51 tax on a retirement fund value of R947 113. In other words, 20.25{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e} of your retirement benefit will be paid to the South African Revenue Service (Sars).

How this is calculated is that your capital will be taxed on a sliding scale. The first R25 000 is tax free, the next R635 000 will be taxed at 18{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e} and the balance will be taxed at 27{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e}. Although not relevant in this instance, any amount over R990 000 would be taxed at 36{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e}.

However, you can avoid this tax entirely by transferring the benefit to a preservation fund. This is an option you should seriously consider.

A preservation fund works in the same way as a retirement fund, except that you don’t have to keep contributing to it. You will be able to make one withdrawal from this fund before your retirement date, but otherwise you won’t be able to access the money until you turn 55.

Once you retire from the fund, the first R500 000, less any amount you have already withdrawn, will be paid out tax free. At this point you can withdraw up to one third of the capital as a lump sum if you like, but the rest must be used to arrange a monthly income during retirement. You will be taxed on your monthly income according to Sars income tax tables.

Why this is particularly important is because if you withdraw your retirement capital now, the R500 000 tax-free benefit that you would receive when you actually retire will fall away. So you will be suffering a double tax penalty.

Apart from the tax you will have to pay now, you should also consider the important differences between putting the money into a preservation fund and taking it out to invest yourself.

 

Income tax paid on your investment

In any retirement product, no annual taxes are paid on interest or dividends. When it comes to discretionary investments, however, the interest you receive on your investment during any tax year will be taxed and you will liable for dividend withholding tax. You will also pay capital gains tax should you withdraw money from your discretionary investment for any reason, including switching funds.

 

Liquidity

If you withdraw the funds now and invest the after tax amount, you will have easy access to your money. However, if you transfer it to a preservation fund, you could only make one withdrawal from the fund before retirement.

 

Underlying investment funds

The Pension Funds Act has prescribed limits for different asset classes which are the building blocks of the underlying investments funds. The purpose of the limits is to contain the investment risk of the underlying investment funds.

However, by doing this, the Act also limits the potential upside of your investment. A discretionary investment can be 100{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e} invested in equities (shares) and also 100{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e} offshore, whereas any investment that falls under the Pension Funds Act can have a maximum of 75{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e} in equities and 25{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e} offshore.

How to track with your retirement savings

In this advice column Aviwe Gijana from Alexander Forbes answers a question from a reader who isn’t sure if he’s saving enough.

Q: I recently turned 45 and am afraid that I haven’t been saving enough for my retirement. I currently have R600 000 in a retirement annuity and a small money market investment that I use for large expenses like holidays.

How do I know whether I am on track for retirement? And if I’m not, is it too late to catch up?

There are many issues one has to consider before retirement, such as: How much debt do I have now and will I have any remaining at retirement? Are my kids still at school and will any of them need financial assistance when I am retired?

The most compelling question for a retiree is however: Am I going to be able to afford to live a comfortable lifestyle off the pension amount I receive?

Situations are different for every one of us, which is why it is very important to sit down with a financial advisor well ahead of retirement age. This will allow the necessary time to determine if your income will be enough in context of the potential expenses you may incur during your retirement years. Expenses may include items such as groceries, medical aid, rent or bond and fuel or transport money.

When a client asks me if they have saved enough for retirement I can only give a comprehensive answer if I have the following information: their current income and expenditure, and their contribution rate towards their pension fund and/or retirement annuity.

In addition, I need to know their planned retirement age, marital status and number of dependants. I also have to have an in-depth discussion about the type of lifestyle they envisage having in retirement.

I then use all this information to inform our discussion around possible annuity choices, as this also feeds into whether the level of savings will be adequate. There are different ways to structure your income in retirement, and these come at different costs.

Based on the information the reader has provided, it’s impossible to say whether, in his personal case, he is on track. I would rather advise him to sit down with an adviser who would have the appropriate financial analysis tools at their disposal to come up with a comprehensive analysis. They would be able to calculate, based on his current level of savings and projected retirement age, whether he could retire with an adequate amount of savings.

Following that discussion, the reader could then take some remedial action if it’s needed. That could be in the form of additional contributions to his retirement annuity, increasing his savings period by planning to retire later, or by revising his expenditure.

Save enough for retirement if you only start at 35

Employees in their twenties could be tempted to postpone saving for retirement for a decade or two, arguing that they would make up the shortfall later on when they earn a bigger salary.

Even where young workers do save from day one, the fact that many people don’t preserve their retirement benefits when they change jobs, effectively mean they also defer saving for retirement. More than two-thirds of pensioners who participated in Sanlam’s Benchmark Survey 2016 indicated that they did not preserve their savings when changing jobs and it is no surprise then that only 35{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e} of the same group believed they have saved enough for retirement.

A research paper by David Blake, Douglas Wright and Yumeng Zhang called Age-Dependent Investing: Optimal Funding and Investment Strategies in Defined Contribution Pension Plans when Members are Rational Life Cycle Financial Planners investigates a retirement funding model that spreads the income earned as smoothly as possible from the time an individual starts working until the day she dies.

Discussing the implications of such an approach at the launch of the survey, Willem le Roux, actuary and head of investment consulting at Simeka Consultants and Actuaries, said quite controversially, the model demonstrates that the member would save nothing before the age of 35, but from age 35 she would save every increase received above inflation towards her retirement.

“So you are basically capping your standard of living from age 35.”

However controversial such an approach would be, at the very least anyone aged 35 and younger has no reason to bury her head in the sand in the belief that retirement is going to be tough, Le Roux said.

“In fact, the future can still be very rosy.”

But postponing will come at a cost. Based on the average member, contribution rates could get as high as 35{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e} by the age of 60, according to the model.

Le Roux said as an actuary he wouldn’t recommend that everyone under the age of 35 should contribute nothing towards their retirement.

Saving is a culture and it would be very difficult to start saving large portions of your income towards retirement when you’ve saved nothing for a decade.

It would also be extremely challenging to cap your standard of living from age 35.

There are also other factors to consider.

In South Africa, a member won’t be able to contribute 35{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e} of his or her salary in a tax-efficient manner.

“You can deduct from tax 27.5{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e} [of your] contributions and of course if you are a high income earner, you’ve got the R350 000 rand cap to worry about as well,” Le Roux said.

The model also suggests that contributions should be fully invested in equities until around age 50. After 50, the member should gradually start converting from equities into inflation-linked bonds and the equity exposure should reduce to between 20{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e} and 50{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e} by retirement age, depending on your risk profile.

“Now this confirms what I always like to say – that the secret to investing is addressing the right risk at the right time. Investing in equities addresses the risk of insufficient returns for the long-term whereas investing in inflation-linked bonds protects the income that you can purchase after retirement.”

In the local market however, Regulation 28 of the Pension Funds Act, only allows a 75{abaf7da085c97d97c5749780ad44a0e55d5a01fb0b713ae478e338e15f926a8e} equity exposure.

“There are ways around it, but that is another challenge.”

Le Roux said it would also be difficult for the industry to communicate effectively with members about such an approach.

The graph below highlights the impact of various contribution strategies on a pensioner’s net replacement ratio (the percentage of the member’s salary just before retirement that she can expect to receive as an income in retirement).