Question

My mother (75) inherited R5-million after the death of my father. The money is currently in the bank and she’s using this to fund her day to day living expenses which come to around R20 000 a month. 

I am concerned that this may not be the best way of managing her finances. Do you have any suggestions?

Answer

There are a couple of issues that your mother would need to take into consideration. 

Longevity & pensioner inflation

She must ensure that the R5m she inherited will give her enough income for the next 25 years as one in 10 of us will live to 100.  In addition, this income must cope with pensioner inflation which is than the regular inflation rate.

Bank deposit

If she keeps the R5m in the bank and it earns, say 7% interest, she will get an income of R350 000 a year.  As she is over 65, the first R34 500 in interest will not attract any tax.

Her after tax income will therefore be around R26 000 a month and the after tax return on the investment will be around 6.3%

If key items in her budget like medical and electricity are increasing by more than this rate, she could find herself in financial trouble after 5 years.

There are a couple of alternative investments that she could consider:

Flexible investment

This is a portfolio of unit trusts where some of the funds are in conservative short term investments that will provide her with a stable income and others will be in portfolios that have a longer term focus.

It is important that these portfolios are correctly structured and are monitored to ensure that they deliver the returns needed without risking the capital.

The advantage of using a flexible investment is that the income that your mother receives will attract very little tax. The bulk of the income that she gets would be classed as a capital drawdown and the remaining part would be seen as a capital gain.  Capital Gains Tax is much lower than normal income tax.  You get an annual R 40,000 exclusion after which only 40% of this gain is taxable. 

If she drew an income of R350 000 and 10% of this income was classed as a capital gain, then the gain would be R35 000.  As the first R40 000 of the gain is excluded, the would be no tax payable on this income.

I would recommend that she does not draw down more than the 5.5% that the FSCA recommends for a 75 year old. Her monthly income would therefore be around R23 000 after tax.

Voluntary life annuity

A nice way of removing the risk from your mother’s investment is to take out a voluntary life annuity.  Here she would receive a guaranteed monthly payment for the rest of her life.  This would typically be structured to increase by an agreed amount each year.  The income would be guaranteed, regardless of what happened on the stock market.

For example, if she invested the full R5m into the life annuity, she would get a monthly income of R45 000 increasing by 5% a year for the rest of her life.

What is nice about a voluntary annuity is that only part of the income is taxable.  In the example above, only R14 400 will be taxable so her monthly after tax income will be R44 600

A downside of investing all the funds into an annuity is that your mother will lose access to any capital should she need a lump sum of an emergency.

Hybrid solution

An option to consider is to invest say R1m into a living annnuity and keep R4m in a flexible investment.  This will give her

As the taxable income is below the tax threshold, the full R25 600 will be taxfree.

With the hybrid solution, your mother will have access to R4m of the funds should she have an emergency or, for example, have to move into frail care.  These funds would also be available for her family to inherit should she pass away

As you can see, there are several options to consider when it comes to investing her inheritance.  I would recommend that she speak to a skilled financial advisor.