Do I have to purchase an annuity at retirement?
When I reach retirement age, must I invest my provident fund in an annuity, or can I just build a unit trust portfolio with an asset manager and draw a yearly “salary” of not more than 4%? Will there be any tax implications?
A provident fund (unlike a pension fund or retirement annuity ) allows you to take the full amount as a lump sum and you do not have to purchase an annuity. However, the tax implications are significant. You may qualify to receive the first R500 000 tax free (if you have made no withdrawals before retirement) but the rest is taxable as per the retirement tax tables.
For example, on R1 million you would pay R130 000 in tax. Any amount about R1 million would be taxed at 36%. This means you pay more than a third of your retirement fund to the taxman. If, however, you buy an annuity, there is no tax payable.
Apart from the tax on the lump sum, if you choose not to purchase an annuity and rather invest the money yourself outside of an annuity, then you will pay capital gains tax, dividend tax and interest income tax on your portfolio.
Within an annuity structure, these investment taxes do not apply, but you pay income tax on the income that you draw from the annuity. So you need to do a proper assessment before making the decision.
It may make sense to take the R500 000 tax-free portion (if applicable) and purchase an annuity with the remaining amount.
Help, my retirement funds are running out
I have been retired for less than 6 years and 18% of my investment capital has been wiped out. I draw 10% of my provident and it has only given me about 4% growth. I am considering moving to a guaranteed fund that gives me 7%.
It is impossible to draw down more than 5% of your retirement money each year and hope that it will last your whole life. According to the The Association for Savings and Investment South Africa (ASISA), if you draw 5% of your capital each year, then your income should only start to reduce after 30 years. If, however you draw down 10% of your capital each year, your income will start to reduce after seven years. This is based on a market return of 10% after fees.
If you switched to a fund with a 7% guaranteed return, it would not solve your problem as you would still see a reduction in your income after six years. If you were to reduce your drawdown to 5%, then your income would start to reduce only after 19 years.
Unfortunately, we have had very poor market returns over the last four years which has worsened the situation. In a weak market like the one we have been experiencing, even a 5% drawdown would start to reduce your income within 14 years. Hopefully the tide will soon turn and we should see improved returns from the market.