Wealth managers cannot control things such as market performance, but they can control strategic decisions that impact a client’s financial future. One such controllable factor is the timing of retirement. Your retirement date is set in your employment contract, but you can choose the date on which you want to retire from your employer’s retirement fund.
Timing is a strategy to consider when retiring and transitioning into a living annuity.
When you retire, there are three important dates to consider:
- Retirement date. Your official last day of work.
- Retirement date of the fund. The date you decide to start the process to convert your retirement fund into a living annuity and receive your cash lump sum.
- Effective date of the living annuity. The date your living annuity funds are invested and the month when it begins to pay an income. This month becomes your anniversary month.
This determines when you are allowed to:
- adjust your income withdrawal (payment) rate annually; and
- change the frequency of your income payments (monthly, quarterly, semi-annually, or annually).
Although this may seem straightforward, the complexity lies in the tax, particularly when switching from monthly to annual income payments.
How tax implications can affect your retirement income
When the South African Revenue Service calculates your annual tax liability, it assesses the total income received in one tax year, including your living annuity payments. In South Africa, a tax year runs from the beginning of March to the end of February.
Let us assume:
- Your retirement date is April, and your living annuity starts in June (making June your anniversary month). Your income for May is covered with your additional savings.
- You want to receive R30 000 a month before tax because that is what you earned before retirement.
- You decide to receive an annual income payment (once-off) from your living annuity in June, as opposed to monthly income payments, because this aligns to your specific needs for the next 12 months.
Here is what happens:
- For March and April, you received taxable income from your employer totalling R60 000.
- In May, you used after-tax savings that do not add to your tax liability for the year.
- In June, you receive your annual payment of R360 000 from your living annuity.
- Overall, you have effectively received 14 months of income instead of 12, which could push you into a higher tax bracket. In this example, your marginal tax rate jumps from 26% to 31%.
- In the second year of your retirement, if you choose to take your income as an annual income, this abnormality will not happen again. If you choose a monthly income, you will be taxed for nine months’ income. The increased or decreased income could happen if you change the frequency or drastically change your income amounts.
Align your anniversary with SARS’s tax year-end
On average, it takes about two months to set up a living annuity after retiring from an employer fund. If you plan to retire from the fund in December, your living annuity will likely start in March, aligning your anniversary month with the start of the new tax year. The benefits include:
- Easier tracking of overall tax when adjusting the frequency of withdrawals. This flexibility is not really required if you get your income monthly but could cause complexity when changing frequency from monthly to half-yearly or yearly.
- Easier management because your income adjustments align with changes in SARS’s tax rates annually.
The process: From retirement date to living annuity effective date
To align your living annuity’s effective date with the start of the tax year, you can follow these steps:
- Consult your human resources department
You might have to take early retirement if you want your final working day to be in December or January and have to earn an income immediately. This means you could give up income leading up to your normal retirement date.
If you have additional savings, you can potentially become a deferred retiree on the fund. You will stop working on your normal retirement date, but you leave your money in the fund until you decide to start the process to set up a living annuity, utilising your savings for the period leading up to that time. By using savings that are not subject to income tax, you can also save tax.
- Co-ordinate with the retirement fund administrators
Confirm the timeframe needed to process your retirement. This process can take up to six weeks for the cash lump sum to be paid out. The service provider typically needs the money for the living annuity to be invested by the middle of the month to receive an income at the end of the month. If this money is only received after this cut-off date, your income will only start the following month.
Ensure you have other investments in place to provide an income during the transition period from retirement to your living annuity effective date.
Be aware that delays can happen for various reasons during the process. Even with the best pre-planning, it is not always possible to align the start of the annuity with the beginning of the tax year.
Bongani Msimango is a wealth manager at Alexforbes.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article is a general guide and is not a substitute for advice from a qualified financial planner.
