Let’s talk about debt at retirement
OPTIONS: KEEP ON SERVICING OR REPAY BILL?
Including repayments in your budget leads to tax leakages.
With debt exposure at an alltime high, it has become quite the norm for retirees across all levels of income to still have outstanding debt at retirement. One of the questions I constantly get from clients is, “What is the best way to handle debt in retirement? Keep on servicing as normal, or repay it?”
A simple way could be to just include the monthly debt repayments in your budget as part of your income needs. Below are my explanations as to why this is a very ineffective way of planning and why there will be tax leakages or wastage.
Before we start, it’s essential to understand your choices at retirement and the tax implications. My reasoning will all make sense as you read further.
At retirement, you have the choice of taking a one-third lump sum, and the other two-thirds need to be invested in a living or life annuity.
The first R500 000 is taxed at 0% if you haven’t withdrawn previously from a pension or provident fund. Amounts over and above are taxed according to the retirement withdrawal table. The income from your two-thirds is taxed according to the Sars tax table. You pay PAYE (Pay as you earn) tax on the monthly income payments from your invested two-thirds.
As an example, Andrew, 65, has a pension fund with a value of R11 million. He has a property that he hasn’t managed to pay off. The original bond amount was R2.5 million at a 7.5% interest rate over 20 years. He still has five years to service the bond, and his current monthly repayments are R20 139 per month.
Apart from the R20 139 per month he needs to service his bond, he needs an after-tax income of R33 000 per month for all his other monthly expenses. Thus, Andrew needs an after-tax income of R53 139. He will need to withdraw R73 000 per month or 7.96% (if he doesn’t decide to take one-third) as a lump sum and commute the R11 million to a living annuity).
There may be a better way to structure his retirement by paying off his debt and thus decreasing the pressure on his budget and investment. The outstanding balance on the property is R1 018 856 with an interest portion of R209 673.
If we decide to withdraw R1.3 million from the available lump sum, the tax will be R220 500 on the withdrawal (which is more than the interest). He will settle the property and will now only need a post-tax income of R33 000 per month.
This means that he will only need to withdraw R40 450 per month or 5% from his two-thirds (R11 000 000 – R1 300 000 = R9 700 000). This will also mean that he will have tax savings of R12 388 per month, R148 656 per year, and R743 289 over the five years.
The fact that he will save R743 289 purely on income tax over the five years, as well as reducing the pressure on his living annuity (7.95% to 5%), will also increase the number of years that he will be able to withdraw an income from his fund.
I’m trying to bring across that one can save a lot of tax and interest by effectively using your one-third lump sum. You can save a lot of tax and decrease the burden on your living annuity.
Everyone’s situation is different, so do a thorough calculation and weigh these up against each other. You will be surprised how much you can save and enjoy a happy, long-lived retirement.
How you can save and enjoy a happy retirement