Our earlier article on what a million Rand will buy you sparked a lot of interest. Based on that let’s delve into the dark world of retirement options.
Let’s make it personal and fast forward ten or twenty years into the future by looking at your retirement, shall we?
So today is your last day at work. From Monday you’re officially a pensioner. From Monday your money has to start working for you, and not the other way round.
So what are some of the decisions you would have had to make before retiring? We start off by asking two questions.
Question one – Are you on a pension or provident fund?
From March 2016 there isn’t going to be a difference in the tax treatment between the two. Everything I’m saying below about provident funds will no longer apply.
A provident fund works like this:
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%.
And 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%.
Why pay tax on something they’re giving to you tax-free? At least take the tax-free amount.
Compulsory ad breaks ahead…or you can scroll down and carry on reading the rest of this article.
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.
Compulsory purchase because you must invest your pension capital into a taxable annuity. You also get a voluntary purchase annuity which is the same except for the fact that your capital isn’t taxed.
What’s the difference between the two types of annuities?
A living annuity allows you to maintain control over your retirement money subject to certain conditions.
You get to take all the risk, and in return, you get to keep all the gains and losses.
If you die on day two of retirement, your beneficiaries get to keep whatever’s left over. If you take too much money, and run out before you die, well that’s just tough for you.
With a conventional annuity, you hand over control of your retirement money to a life insurer.
They get to take 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.
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 doesn’t offer the same ‘Get out of jail free’ card.
The next article in this series will deal with living annuities. I will then follow that up with one on conventional annuities, and maybe in between, I’ll show you what type of income a R5 million pension or provident fund will buy you.
In the meantime I’d like to know which retirement option you’re more interested in:
- Taking all the cash you can
- Taking only the tax-free amount, or
- Taking nothing in cash
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