Question

I am 68 years old and live on the proceeds of an R8 million divorce settlement.  This is invested in a number of bank deposits from which I currently receive around 8.5% in interest each year which is more than enough to meet my monthly budget of R40 000 a month. I have no other income or pension.

In a recent article, you showed a reader how to reduce the tax that they pay by restructuring their investment.  Is there anything that I can do to improve my situation?

Answer

If I look at your current situation, you have the following:

Your monthly income will attract 22.8% in income tax which comes to R155 196 a year. Your after-tax income would therefore be R43 374 a month. 

Three aspects to your arrangements concern me:

• If interest rates decline in the future, your income will decrease when these bank deposits come up for renewal. If interest rates decline by 0.5%, your monthly after-tax income will drop by R2000.

• Your monthly income needs will increase by at least the inflation rate each year. I do not see how this will be achievable over the longer term with your current investment structure.

• All your investment growth is in the form of income which attracts income tax at the full rate. 

I would recommend that you consider restructuring your investments to reduce the tax burden and generate a measure of long-term growth.

At the moment, all your investment capital is attracting income on which full income tax has to be paid each year.  I propose restructuring your portfolio so that it will only trigger a tax when you make a withdrawal.  In fact, when you make the withdrawal, the only tax payable will be capital gains tax which is 40% of the income tax rate.

I would restructure your portfolio as follows:

Every year, you can rebalance the portfolio to ensure that you have around R1m to meet your income and emergency fund needs.  The magic here is that tax will only be triggered when you make withdrawals from the funds and what is important, it will only be on the capital growth in those funds.

So, if you need R40 000 a month to live on, you would need to withdraw at least R480 000 a year from your investment.  You would take it from the R1m part of the investment that is invested in a fund that targets a return of 8.5%.  There is thus R85 000 in growth on that part of the portfolio. 

You will get the standard R40 000 CGT exclusion from this growth so only R45 000 of the growth will attract capital gains tax.  As this is your only income, you will fall below the threshold and not have to pay any tax.  Rember, the bulk of your income will be classed as a capital withdrawal and will not be taxed.

You now have:

You have now saved yourself over R150 000 a year in income tax and have an investment that, with some management, should be able to keep pace with inflation for the rest of your life.