Worst ways to withdraw retirement savings

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When we retire, we rely on multiple streams of income to keep us afloat. The typical retiree will have a combination of Retirement Annuities (RAs), Tax-Free Savings Accounts (TFSAs) and discretionary savings. All of these will include shares, bonds and cash depending on the accounts you have. Determining how to use these funds in retirement can be tricky and it is easy to make a mistake if you do not know when to utilise the funds. This week I want to take a look at some of the most common mistakes people make when they withdraw retirement savings. Be it in traditional retirement or early retirement (a.k.a. living the dream).

Withdraw tax-free savings first

The tax on your RA is determined by the amount you withdraw and not how long you invest it for. Similarly, how long you leave your TFSA to grow will not impact the amount of tax you pay. So, it is beneficial for you to leave these two investments to grow for as long as possible, or to draw down small enough amounts from your RA for it to be tax-exempt.

On your discretionary investments (that do not form part of the abovementioned vehicles), the taxes increase if you leave it to grow for longer. This is because the investment grows and therefore your capital gains tax liability also increases. So it is beneficial for you to use these funds first. Especially when you retire early and you cannot access your RA yet.

Withdraw too much

In South Africa, you are allowed to draw down up to 17.5% of you RA per year. This is a significant portion and I can understand that it is tempting to draw down that much. However, if you withdraw 17.5% from your RA, your money will be depleted within 11 years. The average person will live way beyond 76 years (or 66 if you retire at 55).

We saw in the article backtesting the 4% rule, that 4% is a good drawdown ratio and will ensure that your money lasts indefinitely. There are some arguing that even 5% will not be an issue (although I think it will be risky). So make sure that you limit your drawdown to something reasonable.

Withdraw too soon

More and more people are opting to cash out their pension savings when switching jobs. In a survey, 35% of people stated that when they move jobs they plan to cash out their pension. This is worrying since you pay significantly more tax if you withdraw early. When you withdraw early, you only get a tax-free portion of R25 000. This is compared to a tax-free withdrawal of R500 000 at retirement age.

Amounts above R25 000 are taxed at 18%, above R660 000 at 27% and above R990 000 at 36%. These are also lifetime limits. In other words, if you withdraw R500 000 on two separate occasions, you will be taxed as if you took out R1 million. Additionally, you now need to save more money to make up for the amount you spent. So leave that money in a preservation fund or transfer it to an RA.

Withdraw after a crash

I’ll admit, this one is difficult to accomplish. The simple theory is that if you withdraw money right after a market crash, whatever the amount is that you withdraw, it will be a bigger portion of your total savings. A way to approach it is to withdraw a little extra in years that the market is doing well. Then if we see a crash, you can use some of this money to carry you during the bad years.

You should however still make sure that you do not extract so much during the good years that you pay too much extra tax. A good way to account for this is to keep the R500 000 tax-free portion at the start of your retirement for years that we do have a market crash.

Withdraw retirement savings at once

When you withdraw retirement savings before retirement, you will pay the tax discussed above. This is true whether you withdraw a portion or all of your savings. When it gets to retirement, you will pay income tax on everything that you take out of the RA and income tax is a bitch. So the best thing to do is to transfer it to a living or guaranteed annuity upon retirement.

In a living annuity, your money is invested in a combination of assets and you live off the growth. These assets typically do not differ massively from the assets you had in your RA. My only advice here is to go directly to the living annuity provider and try to avoid a middle man who will take a large portion of your growth.

The last option, as mentioned, is a guaranteed annuity. It is as simple as it sounds, a provider guarantees you an income for the rest of your life. This income will typically transfer to your spouse upon your death. After that, the income is lost and the provider takes the profit (or loss) depending on how long you lived. Depending on your gender or marital status, these annuities pay between 4% and 7.5% of your invested capital.

The most important rule for retirement savings is to leave it alone until retirement. If you plan on emigrating, it might be better for you to lean towards saving in TFSAs and discretionary savings, but that is a discussion for another day.

Be safe out there,

Hendrik

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Endnote

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Comments

  1. Donovan Webb

    Hendrik,

    I have the unfortunate dilemma, I cannot decide what to do with my finances left in South Africa. I am a 55 year old male.
    I have R200K from an endowment policy which paid out after a 30 year term invested in a Capitec Bank account receiving 7.2% interest p.a. I am about to inherit $550K in the next few months from a deceased family estate. I visit South Africa every few years and use these funds to finance our holiday spending. Don’t know about the TFSA or where else this money can be invested which is safe and returns a reasonable (10%) return.
    I have ZAR1.5million spread over 5 pension funds, 1 provident fund and a paid up retirement annuity which I have transferred to Old Mutual when I finished working for 2 South Africa employers in 2002.
    I live and work in Melbourne and I am financially independent, currently living in a mortgage free home worth Aud$800k, cash in a Australian Bank account Aud$200k @ 1.4% p.a. and a Retirement Fund worth $200k.
    I am thinking of moving & consolidating all the funds to 10X, to reduce the fees I am paying by 2.5%. I am not certain whether to take 1/3 rd cash and take a living annuity with a draw down rate of between 2.5 and 4% or let it grow.

    What advice do you or your readers have for me? What would you do with your finances if you were in my shoes.

    Kind regards

    Donny

    1. Post
      Author
      Hendrik Brand

      Hey Donny,

      Lizelle had some ideas in the comment below for consolidating the funds. I would look at consolidating the retirement annuities simply for reducing the fees. So look at low-cost providers like 10x, Sygnia and Easy Equities as you mentioned. Then you can let it grow until you decide it is time to retire and transfer it to a living/guaranteed annuity.

      I would not transfer funds that are not already in a retirement annuity into an RA simply for consolidation. Only use it as a mechanism to reduce your income tax. Presently, it is subject to capital gains tax if it is invested in shares and this tax is very low. Or subject to income tax on the interest if it is in cash. Once it goes into an RA, the whole amount becomes subject to income tax.

      A tax-free account only allows investment of R33 000 per year so you can invest any extra funds in discretionary index ETFs if you plan to invest for longer than 5 years. Your situation sounds like it is rather complex so it might be feasible for you to chat with an independent financial advisor just to make sure you don’t miss anything.

      Congratulations on becoming financially free and I hope you manage to do everything you always wanted to do and never got time for.

  2. Lizelle Steyn

    When moving your retirement options to a lower cost option, other than 10x, also consider The Allan Gray platform with 100% in the low-cost Nedgroup Investments Core Diversified Fund, an index-tracking balanced fund. If your retirement funds total less than R1.5m, your admin/platform fee will be 0.58% incl VAT and 0.44% incl VAT for the underlying balanced fund. No adviser fee if you deal with them directly. The moment your retirement funds grow to more than R1.5m a sliding scale kicks in and you start paying less than 0.58% on the platform fee. Allan Gray’s administration and accuracy really are superb.

    The last time I checked the 10x total fees (admin/platform + TIC of their underlying balanced fund) were slightly higher incl VAT than the Allan Gray combo mentioned above.

    There’s also Easy Equities where the admin/platform fee for the RA is 0.3% ex VAT and the underlying balanced funds charge 0.6% ex VAT. If you include VAT, that route is also slightly more expensive than the Nedgroup Investments Core Diversified Fund on the Allan Gray platform.

  3. Pingback: Government Employee Pension Fund vs an RA - Tigers on a Golden Leash

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