Bongani Msimango, Wealth Manager at Alexforbes, explains why aligning your retirement date with the tax year makes sense.

One of the key principles that a wealth manager needs to understand is that although many things are beyond our control – like market performance – we do have control over strategic decisions that impact a client’s financial future.

One such controllable factor is the timing of retirement.

While your retirement date may be set in your employment contract, you can still choose the date that you want to retire from your employer’s retirement fund.

When it comes to retiring and transitioning into a living annuity, timing is not just a detail. It can become a strategy to consider.

Three important dates

When you retire, there are three important dates to consider:

1. Retirement date: Your official last day of work.
2. Retirement date of the fund: The date you decide to start the process to convert your retirement fund into a living annuity and receive your cash lump sum.
3. Effective date of the living annuity: The date your living annuity funds are invested and the month when it begins to pay an income. This month becomes your anniversary month. This not just a ceremonial milestone. It determines when you are allowed to adjust your income withdrawal (payment) rate each year, and when you can change the frequency of your income payments (monthly, quarterly, semi-annually or annually).

While this may sound straightforward, the real complexity lies in the tax, especially when switching the frequency of your income payments from monthly to annual.

How tax can affect your retirement income

When the South African Revenue Service (SARS) calculates your tax liability each tax year, they assess the total income that you received in that tax year, including your living annuity payments. In South Africa, a tax year runs from March 1^st to the last day of February.

Let’s assume:

• You retire in April but your living annuity only starts in June (making June your anniversary month). Your cover your May expenses through additional savings you have.
• You want to receive R30 000 per month before tax because that is what you earned before retirement.
• You decide to receive an annual income payment (once-off) from your living annuity in June, as opposed to monthly income payments, as this aligns to your specific needs for the next 12 months.

Here is what happens:

• For March and April, you received taxable income from your employer totalling R60 000.
• In May you used after-tax savings, which doesn’t add to your tax liability for the year.
• In June, you receive your annual payment of R360 000 from your living annuity.
• Overall, you have effectively received 14 months of income instead of 12. This could push you into a higher tax bracket. In this example your marginal tax rate jumps from 26% to 31%
• In the second year of your retirement, if you choose to take your income as a single annual payment, this abnormality wouldn’t repeat. If, however, you choose a monthly income, you will then only be taxed for 9 months’ worth of income. This increased or decreased income could happen if you change the frequency or drastically change your income amounts.

The solution: align your anniversary with the tax year-end

On average, it takes around two months to set up a living annuity after you retire from an employer’s fund.

By planning your retirement from the fund for December, your living annuity will likely start in March. This would align your anniversary month with the start of the new tax year.

This will enable easier tracking of your overall tax when you adjust the frequency of withdrawals. This flexibility is not really required if you get your income monthly, but could cause complexity if you change the frequency of your payouts from monthly to half-yearly or yearly.

Another advantage would be that your income adjustments would align with any changes in the SARS tax rates.

The process

If you want to align your living annuity’s effective date with the start of the tax year, here’s what you should do.

1. Consult your human resources department

You might have to take early retirement if you want your final working day to be in December or January and need to withdraw from your living annuity immediately. This means that you could give up income leading up to your normal retirement date.

If you have additional savings, you can potentially become a deferred retiree on the fund. You will stop working on your normal retirement date, but you leave your money in the fund until you decide to start the process to set up a living annuity, utilising your savings for the period leading up to that time. By using savings that are not subject to income tax you can also save tax.

2. Coordinate with the retirement fund administrators

Confirm the timeframe needed to process your retirement. It can take up to six weeks for the cash lump sum to be paid out.

Also confirm the cut-off date in order for you to receive your first payment by the end of that month. Most service providers have a cut-off date in the middle of the month. If the money is only received after this cut-off date, your income will only start the following month.

Ensure you have other investments in place to provide an income during the transition period from retirement to your living annuity effective date.

Be aware that delays can happen for various reasons during the process. Even with the best pre-planning, it’s not always possible to align the start of the annuity with the beginning of the tax year.

Key takeaways

• You cannot control market performance, but you can plan when you want to transition from your retirement fund to your living annuity.
• Aligning your living annuity’s anniversary month with the start of the tax year could help you manage income payments if you have to change payment frequencies often.
• Consult your HR department and retirement fund administrators to best align your fund retirement date with the tax year end if this is important to you.

Strategic retirement planning is not just about how much you save; it is also about when you choose to retire. Make the timing work for you.

This post was based on a press release issued on behalf of Alexforbes.