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Did you know that it is possible to have enough money but still not be able to sustain your lifestyle in retirement? Having money is not enough. You must also have access to it.
When you retire from a retirement fund and take a lump sum (up to a third from pension funds and retirement annuities; up to 100% from provident funds) the first R500 000 you withdraw is tax-free.
This is a one-off lifetime allowance and applies to the combined value of all lump sums you have taken since October 2007 (with some exceptions). Lump sums before that are disregarded.
Over and above the R500 000, members of government retirement funds (such as Transnet and Government Employees Pension Fund) can also take any value of their lump sum attributable to their period of employment prior to March 1998 totally tax-free.
You should definitely withdraw the tax-free portion, but should you take more? This depends on your need to access more of your money in future.
Remember that you will not have access to the capital in a pension-paying investment vehicle like a living annuity or life annuity.
Some examples of things that require cash:
1. Settling debt when you retire.
2. Goals in retirement: travel, replacing vehicles, replacing appliances, future alterations to your home, and so on.
Let’s look at an example. Say Michael retires at 60 with a provident fund of R5m and his lifestyle costs R200 000 per year. Other goals, such as travel and vehicle and appliance replacement, cost an average of an additional R50 000 each year.
If Michael draws R500 000 tax-free as a lump sum, he would pay no tax when he retires. However he would run out of liquid/accessible capital by age 69.
This means that despite having money in the living annuity, he would not have access to the capital and would therefore not be able to sustain his lifestyle.
If Michael drew R2m as a lump sum he would pay R472 500 tax when retiring, but he would have more liquid capital. This would give him access to money when he needs it and enable him to sustain his lifestyle for longer (age 82).
The liquidity could be further enhanced by increasing living annuity withdrawals in his 80s. Michael can either save tax, sustain his lifestyle or compromise between the two. Tax and liquidity in retirement have to be balanced.
How much you should draw as a lump sum depends on your personal circumstances. As you approach retirement, your financial planner should help you to do “liquidity scenarios”, looking at least 20 to 30 years ahead.
While taking more than just the tax-free lump sum may be counterintuitive, and also painful, remember that the purpose of having money is not merely to have it but rather to enable you to support your desired lifestyle.
In the first example above, Michael saves tax when he retires but loses his lifestyle in retirement. In other words he is asset rich (money in his living annuity) but cash poor (he doesn’t have easy access to it).
By first understanding the purpose behind his money he will be able to make a better choice about how much he should be taking as a lump sum.
Kindly note that this article does not constitute financial advice. All information and opinions provided are of a general nature and are not intended to address the circumstances of any individual.
*Paul Leonard is a certified financial planner and regional head at Citadel.
This article originally appeared in the 3 March 2016 edition of finweek. Buy and download the magazine here.
