Monthly Archives: October 2016

Withdraw your retirement benefit

The short answer to your question is that you will be paying R191 820.51 tax on a retirement fund value of R947 113. In other words, 20.25% of your retirement benefit will be paid to the South African Revenue Service (Sars).

How this is calculated is that your capital will be taxed on a sliding scale. The first R25 000 is tax free, the next R635 000 will be taxed at 18% and the balance will be taxed at 27%. Although not relevant in this instance, any amount over R990 000 would be taxed at 36%.

However, you can avoid this tax entirely by transferring the benefit to a preservation fund. This is an option you should seriously consider.

A preservation fund works in the same way as a retirement fund, except that you don’t have to keep contributing to it. You will be able to make one withdrawal from this fund before your retirement date, but otherwise you won’t be able to access the money until you turn 55.

Once you retire from the fund, the first R500 000, less any amount you have already withdrawn, will be paid out tax free. At this point you can withdraw up to one third of the capital as a lump sum if you like, but the rest must be used to arrange a monthly income during retirement. You will be taxed on your monthly income according to Sars income tax tables.

Why this is particularly important is because if you withdraw your retirement capital now, the R500 000 tax-free benefit that you would receive when you actually retire will fall away. So you will be suffering a double tax penalty.

Apart from the tax you will have to pay now, you should also consider the important differences between putting the money into a preservation fund and taking it out to invest yourself.

The impact of costs

Calculations compiled by Itransact suggest that if an amount of R100 000 was invested over 20 years at an investment return of 15% per annum (inflation is an assumed 6%) at a cost of 1%, the investor would lose 17% of his returns as a result of fees. If costs climb to 3%, the investor would sacrifice almost 42% of his returns.

Unfortunately, it is not always that easy to get a clear sense of what you pay and what it is you pay for, but the introduction of the Effective Annual Cost (EAC), a standard that outlines how retail product costs are disclosed to investors should make this easier.

Shaun Levitan, chief operating officer of liability-driven investment manager Colourfield, says the time spent looking around for a reduced cost is time worth allocating.

“I think that any purchase decision needs to consider costs, but there comes a point at which you get what you pay for.”

You don’t want to be in a situation where managers or providers are lowering their fees but in so doing are sacrificing on the quality of the offering, he says.

“There tends to be a focus by everyone on costs and [they do] not necessarily understand the value-add that a manager may provide. Just because someone is more expensive doesn’t mean that you are not getting value for what you pay and I think that is the difficulty.”

Costs over time

Despite increased competition and efforts by local regulators to lower costs over the last decade, particularly in the retirement industry, fees haven’t come down a significant degree.

Figures shared at a recent Absa Investment Conference, suggest that the median South African multi-asset fund had a total expense ratio (TER) of 1.62% in 2015, compared to 1.67% in 2007. The maximum charge in the same category increased from 3.35% in 2007 to 4.76% in 2015. The minimum fee reduced quite significantly however from 1.04% to 0.44%.

Lance Solms, head of Itransact, says the reason fees remain relatively high, is because customers are not asking active managers to reduce their fees. He argues that it is easier for investors to stick to well-known brands, even if they have access to products that offer the same return at a cheaper fee.

And despite a flood of communication regarding fees, intermediaries are not yet as sensitive about costs as one would have hoped, Kellerman adds.

But there are also other factors to consider.

Although more rigorous regulatory oversight in itself is not necessarily a bad thing, compliance requirements have resulted in significant cost implications for the entire value chain, Kellerman says.

Whichone do you choose invest or put money

Advisors are frequently asked this question. This often has more to do with personal risk preference than with economic rationality. To answer this question, however, certain assumptions must be made, and I specifically won’t look at tax to keep the answer succinct.

The rational answer

Let us assume that the interest rate on the bond is at the prime lending rate. That is currently 10.50%

The second assumption we need to make is about what the risk level of the unit trust in question is. A money market unit trust has a very different risk and associated return goal than an equity unit trust.

A low-risk money market or income fund aims to beat inflation and offer a real return of 1% per annum. Thus, if the R100 000 is in an income unit trust only yielding 7% to 8%, it would be rational to secure the higher guaranteed return of 10.5% and transfer the funds into the bond.

However, if the money is in a balanced fund which generally targets a 5% real return, it would be more rational to remain invested as the real return is in excess of the bond interest rate.

It is also important not to fall into the trap of looking at the short-term underperformance of equity linked funds in a time like now and compare this to a resilient prime rate. This may result in the wrong decision to sell out at the wrong time. Every situation is unique and the best course of action is to get advice from a financial advisor who will look at the big picture and your individual circumstances.

The subjective answer

The other way I would advise a client on this is a more subjective approach – the sleep test. Quite simply, what makes you sleep better at night? Would that be a bond balance of R100 000 lower than it is now with no funds invested, or the same outstanding bond balance but R100 000 invested?

The answer will be different for each individual and there are a lot of factors that influence one’s financial decision making such as your view of debt as either toxic or as an enabler. For some people having R100 000 invested offshore, for example, gives them comfort. Therefore, because the economic rationality argument is often such a close contest, considering the subjective approach may help make the final decision easier.

Lump sum and investing it

The reader states that they are entitled to R5 047 648 as a resignation benefit. For purposes of this comparison, the impact of tax on this amount has not been considered as this could vary by individual.

Let us assume that this money will be invested into a living annuity-type structure in order to provide a retirement pension. Under this scenario, the lump sum is invested and a pension is drawn from this balance for as long as the balance is positive.

To put it simply, this operates similar to a bank account. The account increases with investment returns and reduces by any amount that the reader withdraws in the form of a pension.

It is important to realise that the reader will be assuming both the investment and longevity risk under this scenario. Poor investment performance will impact on the amount of pension that the reader may be able to withdraw. Additionally, if the capital is fully eroded while the reader is alive, no further pension will be payable. However, on death, the balance of the account can be paid out to the spouse or other dependants.

Comparing the two

If we consider this reader’s particular circumstances, in order to match the R27 414 per month pension from the GEPF, they would need to draw 6.52% per annum from the living annuity balance.

For illustrative purposes, we assume that the account balance would grow at 10% per annum and that the reader would require the annual pension to increase in line with inflation at an assumed 6% per annum. Under these assumptions the investment growth on the account will exceed the pension being drawn for around nine years. After that the capital will start to be depleted and will be fully eroded after about 22 years.

Assuming that the reader is 60 years old, it is estimated that the capital will be fully eroded by age 82. If, on average, the account grows by less than 10% per annum, this amount will be eroded sooner. Thereafter, no pension will be available. This illustration demonstrates the investment and longevity risks the reader faces.