I am a 58-year-old retiree with no debt. I did not belong to a pension scheme nor do I have any RA policies.
I have however managed to save approx R8m over time which has been invested in the Allan Gray Equity Fund. My plan as from next year is to drawdown approx R500K per annum to cover our living expenses.
I need to
know if this strategy is correct and also how would my tax be structured. I do
not have any other source of income.
Richard Carter, Head of Product Development at Allan Gray responds:
As this will probably be the most important financial decision for your next 40 or so years, it is worthwhile discussing your options with an independent financial adviser. An IFA will reduce the risk of a disconnect between your expectations, the way you construct your portfolio and the amount of income you draw down.
The key risks (in an investment context) faced by most retirees are inflation, market risk and longevity risk. These risks need to be managed with appropriate asset allocation to drive returns, and appropriate drawdown rates to make sure your money does not run out.
The amount you plan to take out and the asset allocation need to be looked at in conjunction. In essence, the big question is whether your investment will sustain your income for the rest of your life. While it might well do so, it’s a big unknown, and by investing all your money in South African equities and drawing a fairly high level, you are taking on a meaningful risk that the investment returns won’t turn out to be enough.
In broad terms, in order for the income you draw to be sustainable, you need to earn a return higher than the total of your starting drawdown percentage and the amount you increase your income by each year.
Assuming a personal inflation rate of 6% (remember it could be higher depending on your health and lifestyle choices), you would need to achieve returns after fees and taxes of more than 12.25% to ensure your income never runs out. A return lower than that would deplete your capital, and the question then becomes how long it will last.
While an investment in a South African equity-only fund has the potential to deliver sufficient returns over the long term, two things need to be borne in mind.
The first is that equity markets are volatile and there could be years when the returns received are very low or negative, and the second is that the long-term returns going forward could well be a lot lower than in the past.
If either of these happen, you might need to award yourself below-inflation income increases in order to make your investment last. You might be able to live with this risk, but to mitigate it you could think about diversifying your investment by considering an asset allocation fund that uses other assets to reduce market risk.
In terms of the tax element of your question – you will be taxed on any investment income derived from your Equity Fund investment. This will include dividend tax at 15% on any dividends received from the Fund, as well as income tax on other taxable investment income received from the Fund.
The withdrawal of R500k per year will trigger capital gains tax; the maximum effective tax rate for individuals is 13.3%. The first R30 000 of the capital gain will however be exempt. This is based on the 2013/2014 thresholds and percentages and may change in future years.
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