Should you consolidate your discretionary money with your pension money?

If you’re about to retire, it’s completely understandable that you might feel a little nervous as you approach this major life change. It’s human nature to worry about changes to your routine, even when it’s a positive lifestyle change (less stress and a lot more free time).

Persistent doubts about whether you have accumulated enough old-age capital can also be a source of anxiety. If you monitor the balance of your retirement capital on a daily basis, any negative fluctuations could raise new concerns in this regard.

Like many people, you probably have many investment vehicles that you will need to decide what to do with when you retire. These can be discretionary investments such as trust investments, endowments, tax-exempt investments, etc. and pension funds such as superannuation, provident fund, pension fund or preservation fund. Much has been written about whether to take a lump sum in retirement and, if so, how much (considering the tax implications of retirement).

I believe you should take a lump sum where the tax paid on the lump sum will always be lower than the marginal income tax rate you would pay if you took a monthly levy. To make an informed decision, you need to know what impact taking the lump sum will have on your monthly withdrawal.

Rather than looking at pre-retirement benefits and tax advantages, in this article I’ll focus on the implications of post-retirement decisions. If you have withdrawn capital from your retirement fund according to the recommendations of your financial planner, you must decide how best to withdraw the capital you have saved in your various investment vehicles.

My advice would be not to consolidate your discretionary money with your pension money. Assuming you decide on a life annuity (as 80% of South Africans do), yes there will be some inheritance tax exemptions on your pension money, but there may also be exemptions on your money discretionary if you correctly designate the beneficiary.

Let’s look at the monthly tax consequences:

Suppose you have 5,000,000 savings in pension funds and 3,000,000 savings in discretionary capital, such as direct investments, endowments and money markets, and that you are 55 years old and take an annual withdrawal of 5 % on your total investment value.

Consolidating everything into pension money where you can withdraw between 2.5% and 17.5% per annum, the total value would be R8,000,000. This equals R33,333 drawn before tax each month (5% of R8,000,000, divided by 12). The after-tax amount paid will be R26,752 based on the marginal income tax tables.

If instead you decide not to consolidate your pension of R5,000,000 and your discretionary funds of R3,000,000, does the situation change? Since the R5,000,000 represents 63% of your total savings, we will assume that this same proportion will be taken from the monthly levy (63% of R33,333) – i.e. R20,999 before tax. Another R12,333 must then be taken from the discretionary money to arrive at R33,333 per month.

Your R20,999 before tax of your pension money would equal R18,017 after tax. Meanwhile, the capital of your discretionary investments is only subject to capital gains tax at 10.40%, dividend tax at 20% (which is already paid by the company investment) and interest tax at 26%. Remember though that you are entitled to a rebate of R40,000 each year on realized capital gains and R23,800 on interest earned before the age of 65. This means that, depending on the markets and the asset allocation of your funds, you should be withdrawing your money at a rate well below your marginal tax rate.

Your net income would then be: R18,017 + R12,333 = R30,350, as opposed to R26,752 net if you consolidated everything into your pension – a significant difference.

However, it should be noted that while there are many ways to structure and optimize your tax position, the net effect will likely be the same over time.