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Question
I am a 74-year-old widow and recently sold a property for R4-million. How should I invest the proceeds to generate the best after-tax income?
Answer
There are a couple of options open to you and each has its advantages and disadvantages. I will run through two of the most attractive ones and show you the pros and cons of each.
Flexible investment
You can invest your R4-million in a balanced, diversified portfolio and draw a monthly income from it. A 6% drawdown would give you R240,000 a year, or R20,000 a month.
With this route, the money remains yours. You can access additional funds if necessary – for medical expenses, home repairs, family support or unexpected events. And anything left at the end of your life forms part of your estate.
Because the investment stays linked to the market, your income should increase over time if markets continue to grow and your investments are correctly managed. If inflation rises, equities and property in the portfolio generally rise too, helping to maintain your buying power.
There is also a tax advantage. You are not taxed on the R20,000 you withdraw each month. Instead, tax is applied to the growth part of your withdrawal. This means that the bulk of the income you receive is classed as a capital withdrawal, which is not taxable. With the normal exemptions and careful asset allocation, the actual tax impact on your spending income is often relatively low.
This approach does require living with investment risk. There will be years when values fall. Managing this successfully requires discipline, the correct portfolio construction and the ability to avoid reacting emotionally to short-term market noise. If you’re comfortable with the variability and want to keep your capital accessible, this route may suit you.
Voluntary annuity
With the voluntary annuity, you use your R4-million to purchase a guaranteed income for the rest of your life. For a 74-year-old woman, this amount would be R31,000 a month increasing by 5% a year for the rest of your life. This is significantly more than the R20,000 a month you would be able to draw sustainably from the flexible investment.
This income is guaranteed. It arrives every month, regardless of what markets do, and continues for as long as you live. That removes both investment risk and longevity risk. You never have to worry about running out of money in your lifetime.
The tax treatment is also favourable. Because this is a voluntary annuity bought with after-tax funds, only about 30% of each payment is taxable. The remainder is treated as a return of your own capital. As a result, you will pay very little tax on this income.
However, this type of investment has trade-offs. Once the annuity is purchased, the capital cannot be accessed. You cannot withdraw lump sums. And unless you add a guarantee period (which reduces the initial income), there is no inheritance. When you pass away, the payments stop.
There is also an inflation consideration. If inflation averages more than 5% over time, your income will slowly lose purchasing power. The solution many retirees use is to save a portion of the income in the early years to create a buffer for later, should inflation run ahead of your escalation. This route suits you if you value certainty, simplicity and peace of mind more than flexibility or inheritance.
Your choice of solution will depend on your financial circumstances. If you have access to an emergency fund, a voluntary annuity would be a great way to provide you with a guaranteed income stream without having to worry about what is happening in the stock market. If, however, you do not have an emergency fund, the flexible investment could be the answer.
Best of both
You can also consider a hybrid approach where your basic living expenses are covered by the voluntary annuity and the balance is in the flexible investment. Here you will have income security while having access to funds for an emergency or when inflation is higher than expected.
As with most big financial decisions, I would recommend that you speak to an accredited financial planner who can take a holistic view of your finances and structure the optimal solution for you. DM
Kenny Meiring is an independent financial adviser. Contact him on 082 856 0348 or at financialwellnesscoach.co.za. Send your questions to kenny.meiring@sfpwealth.co.za
This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R35.
