Guaranteed Income

Is it possible to increase income in a low interest rate environment?

Mike Estment CFP®

Mike Estment CFP®

Executive Chairman And Private Wealth Manager

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Guaranteed Income



They say guarantees cost money! Normally this is so, but at times, like now, this doesn’t hold water in terms of those of us seeking income.

When considering income, various factors come in to play, including:

  • Your requirements
  • Safety of your capital (Credit risk)
  • Frequency (monthly, quarterly, etc.)
  • Liquidity (is your money tied up and is this maybe a good thing?)
  • How this fits with your overall portfolio? Does it free you up to invest the balance to achieve greater growth, both here and abroad?
  • Importantly, what about tax which reduces your net income materially and is often overlooked!
  • Where are interest rates now and where are they likely to be during the investment term. Whilst this is a bit of a guessing game (forecasting is seldom accurate), rates normally display a wavelike pattern. Rates are used by the Reserve Bank to curb inflation (raising rates) or to stimulate the economy (dropping rates) - This is called Monetary Policy. For individual investors, this can result in a fairly dramatic change in income, notably after tax.
  • Can tax efficiency either positively or negatively influence your overall portfolio?
  • Getting down to brass tacks, what is on offer?

Let’s start with the most important point, being your requirements. If affordable, we currently have 5-year rates way higher than the remarkably low call and short term rates. This is particularly pronounced in SA. This is as a result of the poor status afforded SA by the ratings agencies and a significant need to raise funding. Just as the Moody’s and S & P agencies dropped us to non-investment grade, along came COVID! This has us paying more for medium and long-term cash. Call funds, money market and short-term rates have plummeted at the same time.

Typical of investors, what happens next is a scramble for returns. Credible institutions MUST be chosen as, when rates plummet, the crooks come out to play. Capital loss for most income seekers (typically older/retired investors) is a significant risk. NFB strictly selects institutions who rank among the top five or six in the country. Often rather juicy offerings are declined as our credit process precludes even considering them.

Next, we think that cashflow (frequency of payment of income) must match your needs. Monthly makes most sense but sometimes annual or semi-annual suits specific needs.

A trade-off for better returns is typically that funds are committed for longer periods. Careful consideration of your need for access to capital (liquidity) is important before locking it away. We promote investors considering their entire portfolio when making decisions. This allows us to consider accessibility, income, tax efficiency and other factors when making investment decisions. Notably, most of these guaranteed products offer liquidity but we see this as a last resort.

The next point is about holistic planning. Very often we concentrate, given the busy lives we lead, on the immediate issue confronting us. NFB promotes an “Inc.” approach. This is an inclusive approach which allows us to consider all the investments and issues impacting your portfolio. Key issues include tax, liquidity, ensuring growth, ensuring adequate income, estate efficiency, global diversification, risk and more.

The key point is to avoid a short sighted approach which solves our immediate need to the detriment of “The Plan”.

An often overlooked issue is Income Tax, and other forms of taxation. This necessary factor can radically destroy growth, income and overall value. This overflows beyond just the investor and might, if not properly considered, impact beneficiaries in your estate. Smart planning and forward thinking can dramatically improve this outcome. Income Tax varies from 0% to 45% for individuals, Capital Gains Tax (CGT) is 18% (maximum) and Dividend Withholding Tax (DWT) is 20%. These impact us throughout our lives. On top of this we pay CGT and then Estate Duty on death! Estate Duty on qualifying assets starts at 20% and rises to 25% once the estate exceeds a certain value. Further to this we have begun to encounter offshore Situs Taxes and Inheritance Tax on UK and US held investments!

Legally avoiding taxes, wherever possible, has both direct and indirect benefits which we would be delighted to discuss.

South Africa has a history of fairly high inflation and interest rates. Given recent global rates, poor local economic performance and most recently COVID, our rates have dropped dramatically. Call deposits offer between 2,5% and 4%. Notably, this is before tax. After tax this drops to little more than 2%. Interest rates will go up eventually but given the lack of inflation, this is forecast to be a long way off.

The solution for appropriate investors is to seek materially better returns from secure guaranteed income or growth investments. Bonds which offer higher returns can be bought directly or through Unit Trust type investments. For those of us who suffer higher tax rates, we use Guaranteed Products which offer income or capital growth guarantees. These have a 5-year term and either pay a monthly income or grow to a guaranteed maturity value.

These rates vary as bond yields muddle along. They are currently just above 5% which when considering the really low after-tax returns available on cash, are worthwhile considering.

We attach a working example of the income plan, where the return is better than double a bank call deposit. These investments are offered by several of the top Life Insurers. What is surprising is how their rates on offer vary, from a current low of just over 3% to the best of the top Lifeco’s at a tad over 5%. We establish these weekly and need to note that the rate is subject to confirmation, typically with a few days grace to allow for the administration to be completed. The minimum investment is flexible and varies between Insurers.

We would be delighted to discuss this with you and to assist in determining if it might fit your needs.

income plan


Please contact me for more information

 

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