How to create an investment portfolio and generate an income stream at retirement

*This content is brought to you by Brenthurst Wealth.

By Johan Burger*

As an income earning individual, you have probably made regular contributions to various investment vehicles over the years, whether that be to your employer’s pension/provident fund, a retirement annuity, or your own private cash savings. Over the years, these funds have remained mostly untouched, compounding for several decades and was most likely slightly tweaked here and there as your personal circumstances changed during your lifetime. One can ask the question “what is the main objective of saving for all these years?” The answer, very simply, is to provide you with an income stream the day you retire which must be able to sustain a certain standard of living for you and your family for the rest of your years.

Creating a post-retirement investment portfolio requires a completely different mindset to the strategies you may have used to build up your nest-egg during your working years. Approaching retirement, the entire investment process goes into reverse gear. Once you convert your savings into a pension plan, you will withdraw regular income to live on and usually will no longer make contributions to grow the balance. Investment growth must therefore come from earnings on existing investments.

Read also: Retiring soon… what you need to consider

The period of time that you will be drawing down on your wealth during retirement (whilst still keeping some liquid cash in the bank for emergencies), can last almost as long as the wealth-accumulation phase, depending on when you retire and how long you live. The first step for any retiree is therefore to consult with a qualified financial advisor and have a thorough budget drawn up that will determine all the after-tax needs on a monthly basis that will sustain you for the rest of your golden years.

The first thing that a financial advisor will look at is the lifestyle requirements of the individual to determine whether a living annuity or a guaranteed annuity is the better option, and how to construct the remaining portfolio to draw down income in a tax-efficient manner whilst still keeping cash-on-hand for emergencies and medical expenses.

There are many products to choose from ranging from liquid local to foreign direct investments and can include money market funds, tax-free savings accounts, retirement- or living annuities and/or preservation structures.

The second step is portfolio construction that will allow for that monthly income to be generated and this is where the expertise of a financial advisor becomes essential. Annual reviews with your financial advisor would be required to evaluate your ongoing needs and to determine your living annuity and/or liquid fund drawdown percentages. At the same time, should circumstances require it, the advisor might perform changes to the portfolio by making investment switches.

Read also: Retiring in the time of Covid-19

It is vitally important for any financial advisor to first and foremost establish the amount of risk an investor can and should take based on his objectives and personal circumstances. Given these factors one should also bear in mind that different investment vehicles have different rules. Just because you are retired does not mean you should not have exposure to higher risk investments such as equities or property for example, but a financial advisor will make allocations in terms of your risk profile and what is allowed in terms of regulation.

For example:

Retirement annuities, Pension plans and Preservation pension/provident funds must adhere to what is known as Regulation 28. In short this means there is a prescribed way an investor may invest these funds, but the biggest hurdle is that you can only have 30% offshore exposure within these structures.

Ironically, a Living Annuity is not subject to Regulation 28, so the advisor can invest in any portfolio that meets your requirements. Last mentioned is an investment that stems from RA’s, pensions plans, and preservations funds when you retire after the age of 55 and will be obligated to redeem an income from.

It is no secret that South Africa has been under severe economic pressure for the last couple of years and unfortunately the Covid-19 pandemic has only compounded these constraints to critical levels.

Therefore, these are the strategies to consider for pre-retirement investments before the age of 55:

  • Maximise offshore equity exposure to the maximum of 30%
  • Reduce South African equity exposure given economic risk factors we are facing.
  • Consider alternative conservative asset classes such as bonds to cash with the rapid reduction in interest rates as of late. 

Strategies to consider post-retirement after the age of 55:

  • Retirement annuities less than R247,500 to redeem in full as legislation allows you to do so.
  • Consider retiring from these investments to increase offshore exposure when transferring to a Living Annuity. However careful consideration should be taken when you are still earning an income as income from Living Annuities are taxable. In these circumstances the minimum income of 2.5% should be an option.

An important consideration will be what the most tax-efficient source of income will be for you as a pensioner and registered taxpayer.

At the end of the day, the big question will be where does one draw income from and what are the reasons for that? Is it to reduce taxable income or maintain liquidity for example?

For most people, their income is lower in retirement so you will be paying less tax (the rule of thumb is 75% of your pre-retirement income is what you should aim to achieve), but drawing from an annuity or income fund or opting for drawings from cash balances will have significant tax implications.

For example:

With a nest-egg of R2-million, you withdraw R10,000 per month from your living annuity, your income will be roughly R9,300. These amounts will change depending on the income level and tax implication will be more significant the higher the income level.

However, if you withdraw R5,000 from an annuity and R5,000 from liquid assets like a money market account, which are funds that have already been taxed, the net effect will be close to R10,000 after tax. By structuring your income from different types of investments, you could be saving roughly R700 disposable income per month in this example.

You might be asking, why not withdraw all income from liquid accounts? The answer is simple, one always needs a cash balance for ‘rainy days’ or in times of crisis as we currently find ourselves in. Also, annuities do not form part of an estate and are exempt from inheritance taxes.

Alternative things to consider:

  • When your risk profile requires conservative asset classes, then rather opt to have them in your retirement investments as they are exempt from interest tax.
  • Try and invest the maximum of R36,000 per annum in Tax-Free savings accounts. Maximise 100% offshore allocation and these investments do not attract any form of tax.
  • Retirement money falls outside of the estate. So, the money you put into a Living Annuity from a Retirement Annuity, Pension, or Provident Fund is not estate dutiable and you can bequeath the residue from the Living Annuity directly to a beneficiary.
  • To diversify, take amounts directly offshore that you will not require an income from over the next couple of years. Last mentioned is not just to protect you from rand-weakening, but to gain access to asset classes not available in South Africa.
  • In these uncertain economic times, the importance of an emergency cash fund cannot be emphasised enough.

Your qualified financial advisor will establish the pecking order of where income should be derived from during your retirement. Last in line, for example, will be direct offshore investments, which are longer-term and less liquid options. There are many ways to make income drawings as efficient as possible and should be explored with your advisor.

At end of the day, an experienced and qualified financial planner will indicate what is the purpose of the respective investments and how to compile them within your total portfolio, given legal aspects, tax purposes and your risk appetite. Enlisting the help of a financial professional is key to enjoying a long and prosperous retirement.

Read more about investment planning.

  • Johan Burger is a Certified Financial Planner® professional, Director and head of financial planning at the Pretoria office at Brenthurst Wealth. Johan holds a B.Com degree in Financial Management from UNISA and a National Certificate in Wealth Management. He also studied International Business at Lynn University, Florida, USA. He joined Brenthurst Wealth in 2006.

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