Any upside to withdrawing a third of your retirement fund?

A Moneyweb reader asks: My question pertains to the R550 000 that can be withdrawn tax-free from a retirement fund upon reaching retirement age. Why would it be advantageous to withdraw this money if one has no outstanding debts to service and other cash investments for short-term liquidity? Wouldn’t it be more prudent to consider including this amount when purchasing a living annuity? Doing so could potentially result in a lower annual drawdown rate due to the higher initial investment.

Dear reader,

For the sake of clarity, the R550 000 lump sum withdrawal is taxed at zero percent – but it is also a lifetime allowance and not per retirement fund. In other words, all previous retirement fund withdrawals must be considered before a lump sum is taken from one or more retirement funds. The total over your lifetime should not exceed R550 000; anything above that will be taxed. You have correctly pointed out the majority of people may use the opportunity of lump sum access to clear remaining debt. For those who do not have a debt servicing need, there does remain an advantage in opting for the lump sum withdrawal since this may create or further add to current and future liquidity in their investment portfolios.

Although you have stated that you have access to short-term liquidity, retirement can extend for a long time, and life is not linear. Therefore, be sure to have thought through such decisions in terms of the rest of your lifetime and all the possible lump sum and unexpected costs or opportunities that may arise over this period, which may require access to funds to best avoid regret in the future. Keep in mind that, depending on fund allocations, a portion of investment growth in discretionary investment vehicles to which you can allocate the lump sum funds – such as unit trusts – will be derived from capital gains.

Capital gains tax (CGT) is only applied when a switch or redemption is made from a particular fund, and each tax year the first R40 000 (currently) of this gain is tax-exempt. Any balance above this is included in your taxable income at a rate of 40% of the gain, and thereafter is taxed at your marginal rate.

Benefits of not making a lumpsum withdrawal

If you are confident the lump sum withdrawal amount is not required, there are two primary advantages to retaining the funds within the subsequent living annuity. First, all the returns and growth within the living annuity remain tax-free, and you are only taxed on the income taken from this annuity. This excludes the invested monies from being liable for interest income, dividends, and/or capital gains tax within the annuity.

Secondly, if the funds are retained in the living annuity, this investment vehicle would sit outside your estate, and would therefore not be subject to estate duty or executor fees, provided you have named beneficiaries.

Drawdown percentage

Regarding your last statement about a lower drawdown percentage on the living annuity, you should consider your total investment portfolio and each source you may access to provide the income you need to live on and achieve your goals.

The individual drawdown percentages will differ between each investment vehicle, but a more accurate way of viewing the drawdown percentage would be to total all your income withdrawals as a percentage of all available assets to provide said income. Thus, if you retain the R550 000 in the living annuity or withdraw this in cash, it should have a neutral effect on the drawdown percentage of your portfolio.

The R550 000 lump sum withdrawal is taxed at zero percent