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By Maya Fisher-FrenchTake a maximum of one-third of your capital as a lump sum and invest the rest in a regulated product that will provide an income |
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| A City Press reader wrote to us asking for advice on where he should invest his retirement lump sum. He would be receiving a monthly income from his pension for the rest of his life, but also received a lump sum payout. “Could you advise me on how to invest the money?” Michael asked. “Which would be the best bank and what product should I invest in.”The answer all depends on what income he needs in retirement and whether the income he will receive from his monthly pension is sufficient, says Derick Ferreira, national marketing manager at Old Mutual. |
“During our working years, we focus on growing and protecting our income, but once we retire it becomes about sustaining your income,” says Ferreira, who explains that while you may receive what seems like a large lump sum, the question is what does it mean to you in terms of providing an income for the next 15 to 25 years.Receiving a lump sum If you have accumulated your retirement funds through a pension fund or retirement annuity, you can only take a maximum of one-third of your capital as a lump sum, the rest you have to invest in a regulated product such as a life annuity or living annuity that will provide an income. |
In some cases, an employer may pay you an income for the rest of your life if you were part of a defined benefit pension fund.Only R315 000 of the lump sum is payable tax free, so if your lump sum is more than that you will pay tax according to a sliding scale. In the case of a provident fund, you are entitled to cash in the full value of your fund. However, you will also pay tax on all amounts above R315 000. Given the tax consequences, it is not usually sensible to take the full lump sum. |
| Ferreira adds that most people will need to use the lump sum to generate an income so it would make more sense to limit your lump sum to the tax-free portion and transfer the rest into a regulated income- producing retirement product (annuity) to avoid tax on the lump sum. |
You will pay some income tax on the income you receive, but once you turn 65, you qualify for additional income tax concessions and rebates, thus in effect a lower rate of income tax. Ferreira says the first question one needs to ask is: |
How much income do you need to live? You then need to_ consider any other investments that you can live off or you may, for example, still have a part-tirne job that provides you with an income. Once you understand your needs, this can guide you in terms of how to invest. |
| Income: If you need additional income, you will need to invest in a fund that can provide you with an inflation-linked income. There are many unit trusts that generate income and capital growth, which allows your investment to keep up with inflation. These invest in asset classes that pay relatively high dividends. |
Debt: Ferreira says that if you have debt, such as a mortgage bond or car finance, then using your tax-free lump sum to settle your debts could be an excellent investment consideration as the returns are in effect equal to the interest you were paying on that debt. It also means that you need less income in retirement to meet debt payments. |
Capital growth: If you do not require the income and have no debt, you can invest it for capital growth with the aim of supplementing your income in later years. This may be a good strategy if, for example, you plan on working part time for a few years after retirement and do not need the additional income initially. |
| Beware of cash: Ferreira says you need to be very careful about investing your lump sum in cash. For example, if you retired in 1997 with R3 million and invested it in the bank, you would have received an income of about R36 000 a month as rates were very high. At current rates, you would only receive R12. 000 a month. You are also 15 years into retirement and have little hope of finding other means to earn an income. The interest rate you receive from the bank is usually below inflation, so your buying power is eroded. It is wrong to assume cash is risk free. |
Where to invest for extra income: On retirement, you will need to invest in an annuity product to generate an income. There are several options to choose from, depending on your individual needs:Just making ends meet If you have only just enough money to meet your basic living expenses, then Ferreira recommends a life annuity that pays you a guaranteed income for life. You know how much income you will receive, even if you live until 110 years. The downside is that the income stops when you die, unless you specifically purchase a joint annuity, which continues to pay to your spouse on your death. When selecting a life annuity, Ferreira says it is important that you opt for an inflation adjusted increase each year. Initially, an inflation-adjusted annuity will provide you with less income than a flat-rate annuity. |
But within a few years, that flat income will not cover your living expenses, whereas an inflation- adjusted income will increase and exceed that of the flat-annuity income. It may require you to cut your living expenses or take on a part-time job, but in a few years you will benefit from your prudent decision. It If you find that you do not have sufficient capital to provide you with a decent income, consider delaying retirement by three years. You can increase your income by 20% without further contributions. |
| If you have extra income: If you do not need to convert your full capital into income, then Ferreira recommends a living annuity. A living annuity invests in an underlying investment fund and you can draw down anywhere between 2.5% and 17.5% of your capital as income each year. if in your early years of retirement you are able to supplement your income with part-time work, you may only need to draw 2.5% a year and allow the capital to grow and increase the draw down. These funds are usually linked to the market and the capital value can vary. What is critical is you do not draw more than the funds generate after inflation or otherwise you will run out of money. For example, if you draw down 7.5% per year and the fund delivers 3% above inflation (that would be about 9% at current inflation rates), you will only be able to maintain your purchasing power for 11 years. If you draw down 5% a year, you will maintain your purchasing power for 24 years. |
Fund Selection: If you opt for a living annuity or any income-generating investment in retirement, you need to ensure that it is able to keep up with inflation. “Your main objective is to retain your purchasing power so your underlying investments must match and exceed inflation,” says Ferreira, who recommends a fund with an investment mandate that ‘ aims to beat inflation by 3% a year. |
Get advice: if there is one time in your life that it’s worth getting financial advice, it is at retirement. There are tax implications and you need to understand your income needs and how best to generate those. Find out if your company has an agreement with their service provider, or find a reputable adviser. You will find that good advice pays for itself in the long run. It is important to understand what you are paying for, so make sure all fees are disclosed and discuss the fees in rand terms, not percentages. Some advisers charge by the hour while others charge a fee on the amount of money invested. |
