Strategic financial decisions leading up to and at retirement

Retirement and investment planning can be complex and, in the years leading up to retirement, there are a number of strategic decisions that need to be made. Similarly, at formal retirement, there are a number of once-in-a-lifetime decisions that need to be made to ensure that your portfolio is adequately geared for your retirement years. In this article, we examine the various investment vehicles that can be used to provide for your retirement years and how they are dealt with pre-retirement, at retirement, and post-retirement.

Pre-retirement considerations

Approved retirement funding vehicles – such as pension, provident, preservation and retirement annuity funds – are governed by the Pension Funds Act and therefore subject to Regulation 28 of the Act. This piece of legislation is designed to protect investors against inadequately diversified investment portfolios by placing limits on their exposure to risky assets such as a limit on equity asset class investments being 75%. While previously, foreign investment exposure was limited to 30%, the combined limit – including the African allowance of 10% – has recently been increased into a single limit of 45% of total retail assets under management. As such, when investing towards retirement, it is important to consider the impact that Regulation 28 has on the diversification – and subsequently, the returns – in your portfolio. That said, consider also that investment returns are only one of a multitude of factors that should be considered when structuring your portfolio.

The tax advantages of investing through an approved retirement fund are significant and can provide a counter to the potentially limited investment returns as a result of Regulation 28 restrictions. Remember, retirement fund investors can invest up to 27.5% of their taxable income subject to an annual maximum of R350 000 and can claim their premiums back as a deduction. In addition, investors do not pay tax on the interest earned in their retirement fund portfolio, are not liable for dividends withholding tax, and any disposals are not subject to capital gains tax. Further, restrictions on the accessibility of funds housed in such vehicles mean that invested capital is protected from investor behaviour when emotions are running high in the markets. This is because, depending on the rules of the scheme, funds are generally not accessible until formal retirement. In the case of retirement annuities, the earliest an investor can retire and access a portion of their funds is at age 55.

Generally speaking, when you belong to a pension or provident fund, the only time you can access your retirement funds before retirement is upon resignation or retrenchment, although one should think carefully before doing so as any withdrawals will interrupt the process of compounding interest and wealth creation. Sadly, retirement wealth is often destroyed when individuals withdraw their invested capital when moving between jobs. If future accessibly is an issue for you, you may want to consider transferring your retirement benefit to a preservation fund as this type of vehicle allows investors a once-off full or partial withdrawal before age 55, keeping in mind that while the first R25 000 withdrawal is tax-free, the balance is subject to tax as per the withdrawal tables. While you do have the option of transferring your retirement benefits into an RA structure, bear in mind that you will not be able to access any of these funds before age 55.

Key focus areas: Tax deductions, investment fees, the impact of Regulation 28, accessibility to funds

Considerations at retirement

While the notable tax benefits of investing through approved retirement funds are designed to incentivise South Africans to save for their retirement, in return investors are restricted in terms of what they can do with their funds at retirement. Through the retirement fund harmonisation process, the options at retirement have been streamlined across pension, provident and retirement annuity funds, although there remain certain technicalities when dealing with the vested benefits in respect of provident fund contributions made prior to 1 March 2021. With the exception of vested provident fund benefits prior to this date, those formally retiring from a pension, provident or retirement annuity fund have the option of commuting one-third of the investment, with the first R500 000 being free from tax. Thereafter, the remaining two-thirds must be used to purchase an annuity income for retirement in the form of either a life or living annuity. If you belonged to a provident fund prior to 1 March 2021, you have the option of commuting 100% of your vested benefits with the first R500 000 being tax-free, while the non-vested benefits accruing from 1 March onwards are subject to the same one-third/two-third withdrawals rules as pension and retirement annuity funds. Keep in mind that the R500 000 tax-free amount is calculated cumulatively across all your approved retirement funds and not on a per fund basis.

Many of the decisions that you are required to make at retirement are once-off decisions that you will not have the opportunity to undo, so getting them right is of the utmost importance. For instance, once you have purchased a life annuity you cannot convert the policy into a living annuity because, being a long-term insurance product, the risk has been transferred to the insurer. On the other hand, if you use your retirement funds to purchase a living annuity you can, at a later stage, convert your living annuity into life annuity because your living annuity funds are effectively an investment held in your name. Similarly, once you have taken a cash commutation from your retirement funds, it would not make financial sense to move these funds back into a retirement fund structure as you may have already paid tax on the money and you may be taxed going back into a retirement product. If you elect to take out a living annuity, keep in mind the drawdown restrictions that are applicable as these can impact on your cashflow in retirement. As a living annuity investor, you are permitted to draw down between 2.5% and 17.5% of your invested capital per year, although you are able to adjust your draw down rates annually on the anniversary of your policy. Drawing down too much on an annual basis can erode your capital too quickly while, on the other hand, not drawing enough can have liquidity implications if you need to draw from your discretionary investments to supplement your income. As such, future cashflow planning at the point of formal retirement is an imperative to ensure that your funds are appropriate spread between your compulsory and discretionary vehicles.

Key focus areas: Commutation and tax, living versus life annuities, draw down rates, cashflow planning, timing of formal retirement

Post-retirement considerations

Once you have structured your investments so that they are aligned with your retirement goals, careful budgeting and regular reviews are essential to ensure that your retirement plan remains up to date. A key factor when reviewing your retirement plan is to plan ahead for large capital outflows such as weddings, vehicle upgrades, or overseas travel as these may necessitate the disposal of invested assets which, in turn, can have capital gains tax implications. As your personal circumstances change throughout your retirement years, you will need to adjust the draw downs from your various investments so as to minimise your tax liabilities while at the same time ensuring that you don’t run into liquidity problems. The need to generate investment returns to ensure that the purchasing power of your invested capital is not eroded by inflation must be regularly reassessed against your investment horizon, expected longevity, your tolerance for risk, income needs and the cost of living. Rebalancing your investment portfolio to ensure that it is appropriately weighted is an important part of your post-retirement planning, keeping in mind that the allocation of your invested capital will no longer be subject to Regulation 28 limitations. If you’re invested in a living annuity structure, you are free to tailor-make the underlying investment portfolio so that it is fully aligned with your objectives, time horizon and draw downs. Similarly, if you have capital invested in a discretionary portfolio, you remain free to rebalance your portfolio as you see fit, although it is important to be aware of any potential CGT liabilities when disposing of units or switching between funds.

Key focus areas: Annual draw down reviews, planning for capital outflows, investment strategy, liquidity planning, tax planning

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