49 – Tax-efficient ways to make up for the shortfall of a defined benefit pension fund

by | Nov 19, 2024 | Retirement

Question

I retired three years ago, with half my income coming from my company pension fund and the other half from interest from investments. I am paying tax at a rate of 41%. Is there anything that I can do to reduce this amount?

Answer

The type of pension that you describe is called a defined benefit pension. What is nice about this pension is that you know exactly how much you’re going to get each year. Even if the stock market collapses, you will get your pension each month. But there are two drawbacks that you need to watch out for: 

Annual increases 

The annual increases on these funds do not always keep up with inflation, let alone pensioner inflation. The biggest expenses for pensioners usually include medical aid and electricity. These increases have been way higher than the consumer price index (CPI). 

Spouses pension 

Many of these funds have a clause that reduces the spouse’s pension by 50% when the pensioner dies. This can be problematic if the spouse does not have a pension of their own. I maintain that a 75% pension works better for most people, but that is not always offered as an option. 

There are a few options for you to consider when it comes to investing the proceeds of the property. 

Endowment policy 

If you are paying tax at a rate that is greater than 30%, then you should consider using an endowment policy as the vehicle for this investment. Endowments are taxed at 30%, so if your personal tax rate is higher, you can invest in the same portfolios and end up paying a lot less tax on the growth. 

You are also able to attach a beneficiary to the investment so there will be a saving on executor fees. In the case of your investment, this could be as much as R120,000. 

Your type of pension usually comes with a five-year guarantee – the full pension will be paid for at least five years, even if you should die before then. This removes the big downside of endowments, which is that they are not that liquid in their first five years. 

You can also have access to some nicely structured portfolios that are not ordinarily available elsewhere. You could, for example, invest in a portfolio that targets a return of inflation plus 5% with a lower risk profile than is usually the case for portfolios that target aggressive returns such as this. 

Once the five years have elapsed, you may make withdrawals from the investment and use it to supplement your pension or pay for unexpected expenses. 

When the time comes, your wife can also use some of the proceeds to buy a life annuity for herself. This should be more than enough to make up the 50% shortfall in her pension. 

Joint life annuity 

If you need more financial certainty, then consider taking out a joint life annuity – R3-million should provide you with an income of about R16,000 a month that increases by 5%. This will be paid until both you and your wife die.  

Annuity rates are good at the moment and, by locking them in, you will have a much more certain financial roadmap. This will be more than you need now, so you should get into the habit of investing a large percentage of it initially. I would recommend:  

  • Investing R4,000 a month into a retirement annuity. This will reduce your tax bill, provide tax-free growth and you can mature it when you find your annual pension increases are not keeping up with inflation; and
  • You and your wife each invest R3,000 a month into a tax-free investment. This will set up a tax-efficient emergency fund should you have any major or unexpected expenses.

There are several other options that you can consider, including insured annuities and discretionary income plans. Talk to a financial adviser and find the solution that best suits your needs.

KENNY MEIRING IS AN INDEPENDENT FINANCIAL ADVISER

Contact him via phone, email or via contact phone on the financialwellnesscoach.co.za website

Read more of our articles on the Daily Maverick website or newspaper weekly!

Dec 02 2024

189 – Retirement and risk cover options for employees

Question I have a business with 20 employees.  I would like to put in some kind of retirement fund for them.  Is this financially feasible for our sized company? If so,...
Dec 02 2024

188 – Finding the right annuity for you takes thought

Question I recently heard someone talking about a with profit annuity.  I only know about living annuities and guaranteed life annuities.  How does a with-profit...
Dec 02 2024

187 – What to do if you get retrenched

Question I have just been retrenched and I'm feeling quite overwhelmed by all the decisions that I need to make.  Do you have any suggestions on what the big pitfalls...
Dec 02 2024

186 – Making the most of a medical aid on a budget

Question I would like to join a medical aid after not being on one for the past two years.  I’m 39 with a young child and can only pay around R3 500 a month. I’m...
Dec 02 2024

185 – To quell chaos, your business needs its own will

Question I recently heard someone talking about a will for a business. How does this work?Answer A will for a business documents what should happen to your interest in...
Dec 02 2024

184 – Products that can give employees peace of mind

Question A colleague has recently been diagnosed with cancer. He is going to be unable to work properly for at least three months.  The company will pay him his basic...
Dec 02 2024

183 – Measures to take to ensure that your offshore assets are protected

Question A friend’s husband passed away earlier this year, and the executor says it will take at least three years for his estate to be wound up because he owns shares...
Nov 20 2024

120 – The new two pot retirement fund

Question I retired three years ago, with half my income coming from my company pension fund and the other half from interest from investments. I am paying tax at a rate...
Nov 20 2024

121 – Why you should have separate offshore wills

Question I retired three years ago, with half my income coming from my company pension fund and the other half from interest from investments. I am paying tax at a rate...
Nov 20 2024

122 – How utilising a living annuity can maximise the financial health of your heirs

Question I retired three years ago, with half my income coming from my company pension fund and the other half from interest from investments. I am paying tax at a rate...

Download the Life File