Four retirement myths

Ross Dixon
Ross Dixon

Ensuring a steady income stream sufficient to meet your needs in retirement is the most important and the most elusive aspect of retirement planning. There are many reasons for this. Essentially, this boils down to a dearth of financial literacy, says Ross Dixon, Advice Partner at The Wealth Corporation. 

People believe various myths surrounding investing for retirement and only realise that they have been misguided once they experience difficulties. The most common of these myths include:   

1.     You need to begin withdrawing from your retirement savings from a certain age. 

Many people are under the mistaken impression that choosing when to retire and when to start withdrawing benefits from your retirement savings go hand-in-hand. As of March 2015, retirement fund members can enjoy greater freedom of choice as to when they retire from their fund.  

The Income Tax Act was recently amended so that you are no longer forced to begin drawing a pension from your retirement date. The date on which the lump sum benefit is deemed to accrue is no longer dependent on the normal retirement age but rather on the date you elect. You are therefore now entitled to gradually phase your retirement from a fund while continuing to work either full-time or part-time. 

Those who choose to defer purchasing an annuity face the challenge of meeting their expenses in the interim. Such a scenario is only a viable option for those who are able to continue to work part-time or who have other streams of income such as rental returns or dividends. There is great value in deferring accessing your retirement savings for as long as possible and those that are in a position to do so should certainly consider it. 

2.     Paying the lowest amount necessary in taxes is always best practice.  

While conventional wisdom states that we should pay as little as possible in taxes each tax season by either deferring or avoiding taxes, there are key exceptions to the rule from a financial planning perspective. 

Many people saving for retirement make use of Retirement Annuities for this purpose. Contributions to retirement annuities are made on a pre-tax basis, meaning that tax payments are deferred until the funds are withdrawn. It makes good sense to defer withdrawing these funds for as long as possible so as to maximize pre-tax savings and in this way generate increased retirement savings. However, in certain circumstances, it can be beneficial to pay a greater amount in taxes upfront. 

For instance, at retirement, the maximum lump sum you can withdraw from a retirement annuity or pension fund is one third. This is taxed according to the retirement tax tables which state the first R500 000 is tax free, the following R200 000 is taxed at 18%, the next R350 000 at 27% and any amount above this at 36%.   

It makes sense to make use of the first R500 000 but in many cases taking the knock upfront and paying the 18% on the next R200 000 is wise. The same could be argued of withdrawing the following R350 000 at 27%.  The amount to be withdrawn would depend on your marginal tax rate as you will be taxed as per the stated figures on any lump sum that you take.  In terms of income from an annuity, if 18% is the minimum rate at which you would pay tax, paying it upfront when taking the lump sum is a good idea. For tax payers in higher tax brackets, withdrawing R350 000 at 27% would make good sense for the same reason. 

The major benefit here is liquidity. The lump sum you have withdrawn can then be reinvested in a discretionary vehicle where you can access the funds should you need to.  You can choose not to take the lump sum and transfer all your funds to a living annuity instead. In doing so you will avoid paying taxes (excluding the tax free portion) however you will be restricted to withdrawing the figure you elect from your living annuity. You are only able to choose this figure once per year and you are restricted to between 2.5% and 17.5% of the capital value. Therefore, you will have no access to your money should you need more. By paying tax upfront and investing the funds in a discretionary vehicle, you can target a similar return as the funds in your living annuity but enjoy access to the funds should you require it.   

3.     Choosing the right investment vehicle is the most important factor  

While this is a critically important decision it is not one which should be made in isolation. By choosing an investment vehicle for virtue of the fact that it generates the highest returns you may be exposing yourself to risks which can negatively impact on your cash flow in retirement in the long term.  

For example, a high risk, high yield investment solutions can experience unfavourable returns for extended periods of time. If you are forced to make regular withdrawals from such a fund during seasons where the necessary returns have not been realised, you will deplete your capital base and risk eroding it to the point where it is unable to generate the returns you need in the future.  

4.     You can’t afford to spend this year’s good investment returns.  

As stated above, the key balancing act in retirement involves ensuring that the withdrawals you make from your retirement savings do not endanger your capital base. The solution to this dilemma is to invest in a cash flow matching solution.  

At The Wealth Corporation, our role is to make your money last for your lifetime. We do this by using financial modelling tools that analyse your future cash flows, or, in other words, all amounts to be invested and all projected withdrawals. We then apply sophisticated asset allocation methodologies so as to reliably capture market returns over time. 

As future cash flows have different time horizons, no two investors would have the same investment strategy and each would hold a different combination of funds. The asset allocation of your funds needs to be reviewed on an annual basis as your needs and prevailing market conditions change.  

A financial planning process and solution of this kind ensures that you can spend your retirement capital with confidence, secure in the knowledge that the money you need will be there when you need it. In this way, if markets perform particularly well, you can enjoy the windfall income. And if markets perform poorly over a period, you will still have the liquidity you need in the short term while your capital base has the requisite time to recover returns in the long term. 

About The Wealth Corporation

The Wealth Corporation was founded in 2001. Since then, they have experienced considerable growth and gone through many changes, including the establishment of a national footprint and their partnership with Citadel in 2012. They have a proud history as being thought leaders in the industry, developing best practice in client service and advice processes and leading by example. Their advisory solution offers a complete view of the retirement planning and management process, looking at all aspects of financial and personal well-being. This process is called Integrated Insight.

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