Possibly the biggest and most important job we have as wealth managers or financial advisors is to ensure the appropriateness of our clients’ plan for retirement. I often get asked the question: “How much money do I need to retire?”. The answer is very subjective and depends on the level of income one would need to sustain their lifestyle in retirement. Someone with expensive tastes who spends R150 000 per month is going to have to build up a much higher capital amount at retirement than someone who only needs R50 000 per month to live. With 2022 firmly in our rear view mirror, and the new year upon us, now is a great time to make sure you are on track to hit your retirement goals.

Retirement is a significant life event that requires careful planning to ensure financial security. One of the most critical decisions that retirees in South Africa must make is how to convert their retirement savings into an income stream that will last throughout their golden years. This article will explore the different post-retirement financial products available in South Africa, including living annuities, guaranteed life annuities and tax-free savings accounts.

Living Annuities

A living annuity is a retirement product that allows retirees to convert their retirement savings into an income stream. The key feature of a living annuity is that it gives retirees the flexibility to choose how much income they want each year. Furthermore, on the death of the annuitant, the policy proceeds are paid out to the nominated beneficiaries – either as a cash lump sum or as continued income. If the beneficiary elects to take a lump sum, the capital will be taxed according to the retirement and death benefit tax table. Where the beneficiary elects to transfer the living annuity into their own name, they will be required to draw an income from the living annuity, which will be included in their taxable income.  It is important to note that living annuities are not liquid investment vehicles and simply pay out a monthly income. At retirement however, individuals have a R500 000 tax-free withdrawal option from their chosen retirement fund. Should liquidity be an issue in the overall portfolio, exercising this option can help to resolve this. The below table shows the tax liability from retirement lump sum withdrawals.

Should liquidity be of major concern in the portfolio, you could mitigate this by drawing out a slightly larger amount and pay a small portion of tax. However, it is important to consult a financial advisor in this respect in order to see if more tax-efficient liquidity exists within the portfolio.

Living annuities are governed by a drawdown rule in South Africa which limits the amount of capital that can be withdrawn each year. The drawdown rule states that retirees may withdraw between 2.50% - 17.50% of their capital on an annual basis. Financial advisors often talk about the ‘sustainable drawdown level’. This has come to be known as the 4% (or sometimes 5% rule). Essentially, this rule states that an individual should not drawdown on more than 5% (4% is ideal) of their capital each year. The below table shows the capital that is required for a given level of income at retirement, in order to avoid eroding capital:
 

 

Guaranteed Life Annuities

Another post-retirement product in South Africa that is becoming more popular are guaranteed life annuities. A guaranteed life annuity is a retirement product that provides retirees with a guaranteed income stream for the rest of their lives. The income is based on the retirees' age and the prevailing interest rates at the time of purchase. There are different versions of guaranteed life annuities available in South Africa, including:

• Immediate Annuity: An immediate annuity pays an income from the date of purchase.
• Deferred Annuity: A deferred annuity pays an income from a future date, usually the date of retirement.
• Joint Life Annuity: A joint life annuity pays an income to two people, usually a couple. The income continues when the first person dies, either at the same rate or a reduced rate.
• Escalating Annuity: An escalating annuity pays an income that increases yearly, usually by a fixed percentage.

Guaranteed life annuities are becoming more popular because the income is guaranteed for the life of the purchaser and is not subject to movements in the market. Life annuities tend to provide fairly high income payouts often at the 10% range (including annual increases of 5% to account for inflation). This, however, does depend on both the age of the applicant as well as prevailing interest rates at the time of purchase (which are currently very attractive).  The reason for the slightly more attractive income level is that life annuities cease on the death of the annuitant and so one must be aware that no capital will be left to beneficiaries. The true benefit of this product does however lie in the fact that you will be guaranteed monthly income at a given level until you pass away.

Tax Free Savings Accounts

At our firm, we encourage all of our clients to contribute to Tax Free Savings Accounts (TFSA’s) and consider them an extra retirement booster. TFSA’s are an excellent way for retirees to supplement their income and provide a tax-efficient way to save for their retirement. This is because there is no tax on withdrawals, gains or dividends. The maximum annual contribution to a TFSA is R36 000 and the lifetime limit is R500 000. This means it takes roughly 14 years of maximum annual contributions to hit the lifetime limit. I try and encourage my young clients (those in their late 20’s) to make sure they hit their lifetime contribution limit by 45 years old. Provided they retire at 65, this then means that they have a full 20 years to experience non-taxable compound growth on the amount contributed and can then use the proceeds post-retirement to either increase income or for liquidity purposes, such as a property purchase or an overseas holiday. If used appropriately, the tax-free savings account is a great secret weapon to optimising your retirement income and/or liquidity. Remember, both living annuities and life annuities are not liquid investment vehicles – they simply pay out a monthly income. A TFSA is therefore a great way to boost your liquidity in retirement for those emergency spending needs.

Be smart about Tax

Choosing the correct post-retirement product is extremely important in ensuring you are comfortable in retirement. Quite often a blend of the above products is most appropriate. TFSA’s ensure post-retirement liquidity in the portfolio, life annuities tend to provide the best income, whilst living annuities are great in terms of one’s legacy and leaving money behind for your heirs. However, what is equally important as product choice is maximising tax efficiency. In South Africa, donations between spouses are exempt from tax. Optimising tax using both the husband and wife in a household is therefore recommended. If one partner has substantially more assets in his/her own name, consider ceding some assets to your spouse. This reduces the tax liability for the household as a whole as post-retirement income is split and therefore taxed in a lower bracket.

In conclusion, retirees in South Africa have several options for converting their retirement savings into an income stream. Living annuities, guaranteed life annuities and tax-free savings accounts have advantages and disadvantages, and retirees should carefully consider their options before making a decision. It is important to consult with a financial advisor to ensure that the chosen product is suitable for the individual's needs and goals. As a financial advisor, I would recommend that retirees consider a blend of these products in order to optimise income needs, tax and liquidity. If you are unsure of your retirement plan and need to have a discussion around strategies and products available, do not hesitate to get in touch with me.

This article was published on Moneyweb, 6 February 2023. To read more from Jono, click here