Question

I will be retiring soon and have several assets that I can use to draw an income from. I want to pay as little income tax and estate duty as possible and also ensure that my money doesn’t run out. How do I do this?

Answer

I will go through the steps that need to be followed to get to the right answer.

Draw up a budget

You need to know how much you will need each month. This is crucial for ensuring that you do not run out of money during your lifetime.

Consider using a combination of annuity types

There are two types of annuity that you can use for retirement savings: a life annuity and a living annuity.

A life annuity will give you a guaranteed pension until the day you die. This pension will be much higher than the one you can get from a living annuity. However, once you and your spouse have died, there is usually nothing for your children to inherit. 

I like to use this to cover basic living expenses and use the rest of the retirement savings to fund a living annuity. 

With a living annuity you invest your retirement savings and withdraw about 5% of its value as an income each year. As long as the investment is earning more than the running costs of the investment and what you are drawing as a pension, you should not run out of money. You should be able to leave something to your children. 

The downside of this investment is that you are affected by any movements in the stock market. 

The proceeds of both the living and life annuities are fully taxable as income. I therefore like to use discretionary investments to meet some retirement income needs, as the drawdowns here are usually just taxed as capital gains. 

Estate duty implications

Your retirement funds do not form part of your estate. This will represent at least a 20% saving to your heirs when you die. It therefore makes sense to try to keep a good portion of your assets in the retirement funding category. 

If possible, structure some of your income drawdowns from discretionary investments such as unit trusts, endowments and profit shares. This will allow you to make the monthly drawdowns from your living annuity as low as possible. This enables the living annuity to grow, providing you with more income security and saving your heirs at least 20% in estate duty. 

Do not deplete these discretionary investments, as you need to keep an emergency fund available because there will be times when you will need access to a lump sum of cash.