Always consider the tax and risk implications of a retirement plan

14 Jan 2024

What you need is a bit of clever financial planning to reduce your taxes and ensure your retirement savings continue to grow in a less-risky environment.

Question

My wife and I are now nearly 80 years old. We have just more than R6-million invested in bonds with five-year terms. We have a combined monthly income from those investments of just less than R60,000 a month, and we are generally able to save about R40,000 a month. I challenge you to find a retirement income plan that can beat what we have.

Answer

Well done on getting yourself into a situation where you have more retirement income than you need. I have a few ideas for how you can improve your situation.

Tax

Not all investments are taxed in the same way. The proceeds of some investments are taxed as income whereas the proceeds of others are taxed as a capital gain. When you look at any investment, you need to look at the after-tax returns.

With a bond or bank investment, any interest you receive will be taxed as income at your marginal rate once your annual interest exemption has been taken off. Since you are older than 65, this would be R34,500.

This means that of your R720,000 annual income, R650,000 would be taxed at your and your wife’s marginal rates – I assume that your wife holds some of the bonds and applies her interest exemption as well. This means that 90% of your investment will attract full income tax.

If the funds are held in an investment portfolio, any income that you take from it would be classed as a capital gain. Capital gains tax is 40% of your marginal rate. For example, if your marginal tax rate is 30%, your capital gains tax rate would be 12%.

Structure

Since you are living on a third of the income, it would be better to keep two-thirds of the investment in a portfolio where there is compounded growth rather than to receive the full income and pay tax on it immediately.

I would look at the following approach:

Split the R6-million into two R3-million investments in your and your wife’s names. This will ensure that your marginal tax rates are as low as possible. Remember that donations between spouses will not attract donations tax.

Read more in Daily Maverick: Getting to grips with life insurance premium patterns

Read more in Daily Maverick: How to make inheritance easier for your spouse

You and your wife each invest R1-million in the government bonds and take the combined R20,000 a month income that you are living on now.

You and your wife invest the balance in a portfolio where the growth is capitalised and whenever you need to, you may withdraw funds from it. The tax that you pay here will be at a much lower capital gains rate of tax. The portfolios you choose can have a very similar risk and return profile to your bond investment.

Risk

Bonds have an element of risk inasmuch as they are linked to the sovereign risk of South Africa. This is why South Africa offers better bond returns than, say, the US. The risk of the South African government defaulting is perceived to be higher than that of the US.

If you want to reduce this risk, you may want to invest some of your growth assets offshore. This will also enable you to take advantage of any depreciation in the rand over time.

It is always important to consider the tax implications of any retirement income plan. A bit of clever financial planning can reduce your taxes and ensure that your retirement savings continue to grow in a less risky environment. DM

Kenny Meiring is an independent financial adviser. Contact him on 082 856 0348 or at financialwellnesscoach.co.za. Send your questions to [email protected]

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Question

Answer

Tax

Structure

Risk