I am retiring from an RA and will be investing in a living annuity …. Since no income from the drawdown is needed, the minimum drawdown will be used for the foreseeable future; R500,000 will be withdrawn as cash in advance to take advantage of the non-tax benefit.
Accelerating a decision on retirement needs to be carefully considered, as some irreversible decisions are put forward, sometimes prematurely. If none of these effects of your “early retirement” are deemed detrimental, investors may retire from an RA / pension / retirement / maintenance fund after the age of 55, subject to certain fund rules. This strategy could be very useful if investors are not already sufficiently diversified across their investment portfolios (including discretionary funds). Be careful not to consider just one scenario of currency depreciation or a prolonged economic downturn in South Africa. Your overall financial position should be viewed holistically, against the background of your fixed assets and other liquid / illiquid assets, if any.
Assumption: Your RA is converted into a living annuity that is held by indirect offshore (asset swap) trust funds (similar risk profile; moderate).
My questions relate to the distribution of the remaining funds to invest in light of the above:
1. Is it best drawn from a local fund such as a money market or income fund, or in a proportion of all funds including the global funds?
I prefer to use an asset-liability matching strategy that has a conservative component in which you fund monthly income withdrawals. This allows the advisor to take sufficient risk with the rest of the portfolio. “Income security” seems to offer many investors enough convenience to pursue a growth strategy with the rest of their assets.
2. If maximum global exposure is sought and the drawdown is 100% from local funds (depending on the answer to question 1), how much money should be invested in the local fund? Is it billed enough to cover 2/3/10 years of the drawdown before redistribution is required?
The time horizon for local conservative funds is usually three years or less. If you are considering the minimum purchase of 2.5% per year, two years of income provision from conservative funds should generally be sufficient. Since the rest of the portfolio consists entirely of offshore funds, I would suggest holding at least 10% of the portfolio in local conservative funds to cushion exchange rate volatility.
Should investors opt for a stronger growth strategy (e.g. offshore stocks only), I suggest that your income provision doubles and around 20% is held in local conservative funds.
3. Is an ETF an absolute no-go for the living annuity due to the brokerage fees, with the restriction that the drawdown is NOT deducted from the ETF, unless a top-up may be required for funds with which the drawdown occurs on a monthly basis ? Therefore, there are regularly no brokerage fees.
ETFs (passive unit trust funds) can be used as part of life annuity / old-age provision solutions, provided that their asset allocation is appropriate to the customer’s risk profile. However, I wouldn’t assign more than 10% to 15% to just one passive strategy in any solution.
ETFs sound convincing from a cost standpoint, but few investors (if any) are willing to see their investments cut in half during a market crisis.
4. Will taxes such as CGT be paid when used?
Income deductions are included in your taxable income. Living annuities are not subject to taxes on dividends and interest income or capital gains.
5. If a high percentage is invested worldwide and my risk is moderate, should the investment be diversified and which fund groups (stocks, bonds, cash) should be considered?
Assumption: Max. Exposure offshore
Given that you are not yet dependent on income, along with the edge-absorbing stock market volatility (for moderate ones) one can consider the following asset allocation:
a). 10% local conservative / income funding allocation;
B). 15% global cash / global bonds; and
C). 75% global stocks.
If this is the only retirement plan you have, I’ll include mixed funds for the core 90% of the portfolio, 10% in RSA for income draw (still from 2.5% off – four years of income).
Should you need to withdraw more income at a later date, I would suggest that your portfolio be rebalanced annually.
Please note that several other aspects (e.g. age, greater financial resources, survivors, etc.) can play an important role in portfolio construction.