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How much is your retirement lump sum really worth?

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Elliot wrote to City Press for advice on his retirement package. Elliot, like so many retirees, faces the question of whether to guarantee his income for the rest of his life, or to have less certainty around his income but have the option of leaving money for his heirs. His story is an example of the type of decisions one has to make, and how those decisions affect your retirement income.

Elliot is 64 years old and is due to retire from a government position. On retirement, he can expect to receive a monthly annuity income of R20 000, as well as a lump sum of R912 000. If, however, he resigned, he would receive a lump sum of R3.2 million, which he could then invest to provide him with an income during retirement.

While R3.2 million sounds like a great deal of money, Mark Lapedus, the head of product development at Liberty Investments, says the first consideration that Elliot faces is tax. Retirement funds are taxed very differently, depending on whether you are retiring or resigning.

Resigning and taking the money

1Based on the current tax tables, if Elliot resigned and took his full pension as a withdrawal, he would pay nearly R1 million in tax – reducing his pension to only R2.2 million. Clearly this would not be a good option.

Based on current tax tables, when you cash in your pension on resignation, you pay tax on any amount above R25 000. This is based on a sliding scale from 18% to 36% of the proceeds of your retirement fund.

Resigning and preserving the funds

2If Elliot resigned and transferred the full R3.2 million to a preservation fund, he would not pay any tax. He could then, on retirement at age 65, transfer this to a living annuity, where he could draw an income each month. Lapedus says the recommended drawdown rate is a maximum of 6% a year to ensure the capital is not depleted while Elliot is still alive, and it also ensures that his income can keep up with inflation. On his death, any capital would be paid to his beneficiaries.

Lapedus says that assuming a 6% drawdown and 10% growth on the investment portfolio, the starting income would be R11 490 a month. In this case, Elliot has not had the benefit of the R912 000 lump sum payment because the full R3.2 million has been invested for income.

Resigning, taking a partial sum and preserving the rest

3Elliot could take a partial withdrawal of R912 000 and preserve the remaining capital until retirement. The same tax tables would apply and he would pay about R182 000 in tax on the R912 000 – reducing his lump sum to R730 000. It would also reduce the income he would receive in retirement by nearly a third.

Waiting until retirement

4If Elliot waited until retirement, he would benefit from far more favourable tax rates because you only pay tax after the first R500 000 (assuming you had not made any withdrawals prior to retirement). That means on the R912 000 lump sum, Elliot would only pay R93 000 in tax, leaving him with an after-tax lump sum of R819 000. In addition, he would be receiving an income of R20 000 from the state pension fund.

Lapedus says Elliot’s most favourable option would be to wait until retirement – partly due to the tax benefit and also because of the more generous retirement benefits offered by the Government Employees Pension Fund (GEPF).

Pros and cons of a living annuity

5Lapedus says while the advantage of the living annuity is that a client retains full ownership of the assets on death, the downside is that the full investment risk and longevity risk also sit with the client. So if Elliot lives too long and has a few years of poor investment returns, this affects the ability to earn income. The income is also not guaranteed as it will depend on the investment returns. If the market enters a bear market, this would have a negative effect on his capital and, therefore, his income.

If Elliot prioritises leaving money for his heirs by selecting to resign before retirement, he would face a bleak retirement with less income, and risks, if he lives a long life, running out of money, leaving nothing for himself, let alone his beneficiaries.

If he selects the GEPF offer, he could structure his retirement to meet both objectives of providing a guaranteed income as well as the opportunity to leave a legacy. He could live off the pension paid to him while retaining the lump sum as a potential inheritance for his family. If, however, during his lifetime he needed to supplement his pension, he could draw down on the lump sum

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