129 – How to set yourself up for retirement, even if you start a bit late
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
Here is a step by step way to work out what you should do:
- Work out how much money you will need to live on when you retire
The first step is to work hard how much income you will need when you retire.
You should look at your current budget and identify those items that are likely to increase as well as those that are likely to decrease when you retire. This will give you the after-tax income that you will need when you retire.
- Calculate how much capital you will need when you stop working
You must multiply this monthly budget by 12 to get the annual amount you will need each year. You should then divide the annual amount by 0.05 to get the amount of capital that you need. (We do this because 5% is the recommended drawdown rate on a retirement investment for a 65 year old.
I have attached a couple of examples below:
Monthly pension needed |
R20,000 |
R25,000 |
R40,000 |
R70,000 |
R100,000 |
Annual equivalent |
R240,000 |
R300,000 |
R480,000 |
R840,000 |
R1,200,000 |
Capital needed |
R4,800,000 |
R6,000,000 |
R9,600,000 |
R16,800,000 |
R24,000,000 |
So, if you need a pension of R25 000 a month, you will need at least R6 million in savings. Remember that I have not taken income tax into account so the capital needed will be higher than the numbers in the table.
- How to invest to get to this number
Now that you know this number, you should start investing aggressively in order to close the gap. As you are in your 50s, you are probably earning more money than you have ever earned and as a consequence, you are probably paying the most income tax that you have ever paid. I would therefore recommend such you invest as follows:
Retirement Annuity
You can invest 27.5% of your taxable income (up to a maximum of R 350 000) into a retirement fund and have this investment come off your income tax. You will effectively get an immediate subsidy on your contributions that is equal to your marginal tax rate.
So, if your tax rate is 40%, an investment of R100 000 well effectively cost you R60 000. This is a great way to get the government to subsidise your retirement savings.
Tax free investment
You are allowed to invest R36 000 a year into a tax free investment. The advantage here is that in time to come, you may make tax free withdrawals from this investment.
Discretionary investment
These would typically be investments in unit trusts or specific portfolios. The advantage here is that any drawdown that you make would only attract capital gains tax. This can reduce the amount of tax that you pay when you are on pension. This will in turn reduce the amount of capital that you need when you retire.
Wrapped products
If your tax rate is higher than 30%, you can consider investing into an endowment or sinking fund structure. This can be local or offshore.
The advantage here is that after five years have elapsed and the investment has matured, you may make withdrawals from it that are free of additional tax.
As you can see, there are several products at your disposal. I would, however, recommend, that you speak to a financial planner we can help you select the right combination of products to use at this crucial stage of your financial journey.
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!