What Decision Would You Make If You Were Retiring Tomorrow?
Maybe you are still in your twenties or early thirties and the thought of retirement seems so far away that it just doesn’t feel that important right now. The good news is that if you are still in your late twenties or early thirties you have time on your hands and you should be arming yourself with as much information as possible and saving as much as you can. In this week’s article we are going to be looking at the important decisions you will need to make at retirement.
Let’s assume for a second that today is your last day at work. From tomorrow you are officially a pensioner (the company pay cheques have ended and now your accumulated retirement savings need to start working for you, for the rest of your days)
But before you head off to enjoy your retirement
there would have been a few decisions you would have had to make. Let’s start off by asking two questions:
Question One – Are You On A Pension Or Provident Fund?
Just note that from March 2016 there isn’t going to be a difference in the tax treatment between a Pension or Provident Fund (Everything mentioned below regarding Provident Funds will no longer apply).
This is how a provident fund works:-
When you retire you can take the full provident fund value as a lump sum, after paying the tax. As we speak R500 000 of that is paid out to you tax-free. The rest is broken down into different bands and taxed at rates anywhere between 18% to 36%.
This is how a pension fund works:-
With a pension fund
you may only take one third in cash and that’s after paying the tax (on the one-third). The same formula, regarding tax, applies to a pension fund. The first R500 000 pays out tax-free. If your one-third is more than R500, 000 then you are taxed at between 18% and 36%.
So, the biggest difference between a provident and pension fund
, is that with a provident fund you can access the full fund value (take the whole amount as a lump sum), while with a pension fund
you can only access one third of the value and the balance needs to buy you a pension.
If you need to buy a pension, what are your options?
Question Two –Living Annuity Or Conventional Annuity?
Right now, the two-thirds remaining in your pension fund, at retirement, must be invested in what’s known as a compulsory purchase annuity. An annuity is any product where you invest a sum of money (in this case the two-thirds of your pension fund) and in return they pay you an income for a specified period of time.
So, should you choose a Living or Conventional Annuity?
A living annuity allows you to maintain control over your retirement money subject to certain conditions. You get to decide on which assets your money is invested into and how much you want to draw down as a pension, but with that flexibility also comes the following major risks:
- If you draw out too much money and you run out of cash, it’s your problem
- If you are invested in assets that lose value and it impacts your ability to draw an income, it’s your problem.
A living annuity does give you flexibility, but you need to make sure you seek some financial advice to make sure you get invested into the correct mix of assets, so you don’t run the risk of creating a mess of your retirement monies.
With a conventional annuity you hand over full control of your retirement money to a life insurer. The life insurer takes all the risk and in return promise to pay you an income until the day you die.
If you die on day two of retirement, the insurer gets to keep the money. If you live longer than they expected, and the money runs out, well that’s just tough for them, they will need to continue paying out your pension.
The one nice thing about a living annuity is that you get an emergency parachute. If you get cold feet you can always jump across into a conventional annuity. Unfortunately the conventional annuity clan don’t offer the same ‘Get out of jail free’ card. Once you have invested your money into a conventional annuity, you are locked in.
Ok, a quick wrap up. If you are invested in a Provident Fund you can take the full lump sum amount out at retirement (subject to tax). If you are invested in a Pension Fund, you can only take out a max of one third of the cash and the balance needs to be invested into a pension to provide you an income. Those two pension options
are either a living annuity (you have control of your pension fund monies, but also take on all the risk) or a conventional annuity (you hand the risk over to a life insurer and they will pay you an income until the day you die).
Make sure you always seek professional advice when it comes to these matters
The iHound team