Question

I am a 74 year old widow and have recently sold a property for R4m.  How should I invest the proceeds to generate the best after tax income?

Answer

There are a couple of options open to you and each has its advantages and disadvantages. I will run through two of the most attractive ones and show you the pros and cons of each.

Flexible investment

You can invest your R4 million in a balanced, diversified portfolio and draw a monthly income from it. A 6% drawdown would give you R240 000 a year, or R20 000 per month.

With this route, the money remains yours. You can access additional funds if necessary — for medical expenses, home repairs, family support or unexpected events. And anything left at the end of your life forms part of your estate, allowing you to leave a legacy for your children.

Because the investment stays linked to the market, your income should increase over time if markets continue to grow and your investments are correctly managed. If inflation rises, equities and property within the portfolio generally rise too, helping to maintain your buying power.

There is also a tax advantage. You are not taxed on the R20 000 you withdraw each month. Instead, tax is applied to the growth part of your withdrawal.  This means that the bulk of the income that you receive is classed as a capital withdrawal which is not taxable.  With the normal exemptions and careful asset allocation, the actual tax impact on your spending income is often relatively low.

This approach does require living with investment risk. Markets go through cycles. There will be years when values fall. Managing this successfully requires discipline, the correct portfolio construction and the ability to avoid reacting emotionally to short-term market noise.

If you’re comfortable with that variability — and want to keep your capital accessible — this route may suit you.

Voluntary annuity

With the voluntary annuity, you use your R4 million to purchase a guaranteed income for the rest of your life.  For a 74 year old female, this amount would be R31,000 a month increasing by 5% a year for the rest of your life.  This is significantly more than the R20,000 a month that you would be able to draw sustainability from the flexible investment.

This income is guaranteed. It arrives every month, regardless of what markets do, and continues for as long as you live. That removes both investment risk and longevity risk. You never have to worry about running out of money in your lifetime.

The tax treatment is also favourable. Because this is a voluntary annuity purchased with after-tax funds, only about 30% of each payment is taxable. The remainder is treated as a return of your own capital. As a result, you will pay very little tax on this income.

However, this type of investment has tradeoffs.  Once the annuity is purchased, the capital cannot be accessed. You cannot withdraw lump sums. And unless you add a guarantee period (which reduces the initial income), there is no inheritance. When you pass away, the payments stop.

There is also an inflation consideration. If inflation averages more than 5% over time, your income will slowly lose purchasing power. The solution many retirees use is to save a portion of the income in the early years to create a buffer for later, should inflation run ahead of your escalation.

This route suits you if you value certainty, simplicity, and peace of mind more than flexibility or inheritance.

Your choice of solution will depend on your financial circumstances.  If you have access to an emergency fund, a voluntary annuity would be a great way to provide you with a guaranteed income stream without having to worry about what is happening in the stock market.

If, however, you do not have an emergency fund then the flexible investment could be the answer.  If you do follow this route, I would recommend that you speak to a financial planner who can help you structure your investment and ensure that you are invested in portfolios where your investments  are able to weather any financial storm that you could experience in coming years.

Best of both

You can also consider a hybrid approach where your basic living expenses are covered by the voluntary annuity, and the balance is in the flexible investment. Here you will have income security while having access to funds for an emergencies or when inflation is higher than expected. 

As with most big financial decisions, I would recommend that you speak to an accredited financial planner who can take an holistic view of your finances and structure the optimal solution for you.