Is making a withdrawal from my preservation funds the best option for me?

The overall liquidity of your investment portfolio should be considered when deciding whether to withdraw from a fund and purchase a living annuity.

Stephen Katzenellenbogen CFP®

Stephen Katzenellenbogen CFP®

Senior Executive and Private Wealth Manager

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Is making a withdrawal from my preservation funds the best option for me?

I had my full pension transferred to two preservation funds without any withdrawal. Should I proceed to make a full withdrawal from one or both? I understand I may pay approximately 36% tax. I am 64, turning 65 in November, at which time I think I have to retire.

I can move part of the capital offshore via the discretionary allowance. However, I am unsure as to how it can be invested other than in an existing Channel Islands account where I will lose out on compound interest but may gain on ROE. At one point, emigrating to the UK was an option, but with all the unknowns in the world, we cannot make that decision for now.

I am trying to weigh up if there is anything more beneficial for me other than to cash in a third and purchase a living annuity with the balance.

*Please note that the information provided below does not constitute financial advice; in fact, we are precluded from giving specific advice. Generic information has been supplied given the context of your question. We have limited details about you and your circumstances, and knowledge of further details may impact any advice provided*

Good luck with your impending retirement. While it is an exciting time, I am sure there is apprehension about moving away from a salary to relying on your accumulated savings.

Your question is multi-faceted, and I will endeavour to cover the various touchpoints. There is a significant lack of information around whether this is the extent of your savings; this could have a meaningful impact on your approach to your preservation funds.   

Let us begin with the end of your question: “I am trying to weigh up if there is anything more beneficial for me other than to cash in a third and purchase a living annuity with the balance”. Taking the third can be both beneficial and necessary if you have no other liquidity in your portfolio. Once you purchase an annuity, your only liquidity will be your income, which in the case of a living annuity can only be changed once a year on the anniversary of the investment. If you live to age 95, retirement at age 65 could mean that your accumulated capital needs to last 30 years; a lot can happen during this time which is why liquidity is so important. In most instances, if you have not previously taken a lump-sum withdrawal from a retirement asset, it makes sense to withdraw at least the tax-free amount, which is currently set at R500 000. Essentially, it is cheap access to capital that has been growing free of tax.

On the flip side, one of the potential benefits of retaining as much as you can in an annuity, specifically a living annuity, is that on death, the asset does not form part of your estate, nor does it attract executor’s fees. This benefit is, of course, circumstantial both to your needs and the size and scope of the estate. Another advantage of a living annuity is that growth within the investment - interest, dividends or capital growth - is tax-free. The long-term benefit of an asset that grows tax-free (albeit the income you take is taxable) and is free of estate duty can be meaningful.

The next element of your query deals with what to do with the lump sum from the withdrawal. As your options are plentiful, the advice is going to be specific to your circumstances. If you already have an “emergency fund”, you should probably look beyond cash to a growth asset - specifically something that can deliver a long-term return above inflation. You have referenced a Channel Islands bank account. In the current environment, you are likely to receive close to zero interest on your cash, which will be further reduced by income tax if you do receive interest. If you are looking for a cautious alternative, there is a vast array of options, but some would require taking on an element of risk relative to cash. Suppose your motivation to take the one third is merely to get offshore exposure. In that case, it is important to remember that a living annuity is not governed by Regulation 28, and as such, you can invest up to 100% in foreign assets. With direct offshore investments, i.e. not via a living annuity, you must also consider any probate and situs implications.  

Thirdly, thought should be given as to whether you should purchase a living or a life/compulsory annuity. Here is a comparison table, inter alia:

Living Annuity Compulsory Life Annuity
Select underlying funds (therefore subject to market movements) Guaranteed income for the life of the life assured (risk borne by insurer)
Income drawn at 2.5% - 17.5% of the capital value and is fixed until the next anniversary Income specified at inception and will not vary (income depends on market conditions and interest rate levels at inception)
Percentage of income drawn may be adjusted on anniversary date (once a year) of policy Assured has the option to escalate his/her income every year, but this choice is only available at inception of the policy
Flexibility in the choice of the underlying investments No choice in underlying investments
Income taxed at marginal rate Income taxed at marginal rate
Upon death of the life assured, the annuity passes on to the nominated beneficiaries (various options available to beneficiaries) Upon death of the life assured, the insurer keeps the remaining balance. This depends on whether it is a joint policy and/or if there is a guaranteed period (maximum ten years)
Cannot withdraw lump-sums Cannot withdraw lump-sums
Can be converted to a life annuity Cannot be converted to a living annuity
Can be transferred to another insurer Cannot be transferred to another insurer

Here again, your choice of product is going to depend on your specific circumstances. In the current environment, the rates on compulsory annuities are very compelling and worth considering should you require an income in excess of 5% p.a. of the value of your annuity. I note 5% in this instance, as once you start drawing more than around 5% from a living annuity, you can potentially begin to reduce the asset’s ability to deliver a growing income.

In summary, your decision to take up to one-third of your accumulated retirement savings and whether to take a life or living annuity is going to be circumstantial. It is crucial that you take your time in making a measured decision, ensuring you have all the necessary information at hand.

Is making a withdrawal from my preservation funds the best option for me? 

This reader question was published on Moneyweb.

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