Email your queries to [email protected] or fax them to 021 488 4119. This feature is brought to you by PSG Wealth.
Can I convert to a defined-contribution fund?
I would like to convert my defined-benefit pension to a defined-contribution pension. The rules of my fund state that I do not have this option. I hope there may be legislation that allows for such a conversion.
Peter Dini
Riaan Strydom, a financial adviser at PSG Wealth in Millpark, Port Elizabeth, responds: The options available to members of a retirement fund are dictated by the rules of the fund and legislation. If the rules of the fund do not allow for retirement “outside” the fund, you must abide by those rules.
If you are adamant that you want to remove your capital from the fund, your only option is to resign from your employer before your retirement date and withdraw from the fund. Upon withdrawal, the rules should allow for the transfer of your benefits to an approved fund. A transfer between approved funds is tax-free, so this allows you to move your capital to either a preservation fund or a retirement annuity fund, from which you can retire as if you had belonged to a defined-contribution fund.
Bear in mind that there could be unintended consequences to withdrawing from the fund, instead of retiring in the fund, such as losing your employer’s post-retirement medical scheme subsidy, if applicable. Please obtain advice from a qualified financial adviser and assess your options together.
Can I switch from a living to a guaranteed annuity?
My retirement capital is in a living annuity portfolio, from which I draw down the minimum percentage of 2.5 percent. In future, I may want to put half my capital in a guaranteed annuity (with annual escalations) to reduce my risk profile. According to Bruce Cameron’s book, Retire Right(page 215), it is permissible to split your capital between a living annuity and a guaranteed annuity.
The company that manages my retirement capital says this cannot be done across companies, and that I would have to place my capital in a composite fund with one life assurer. I do not necessarily want to withdraw all my capital from my current portfolio managers, because they have managed my portfolio quite well over the past four years. Can you provide clarity on this matter?
Wayne van Rensburg
James Wiles, a financial planner at PSG Wealth in Melrose Arch, Johannesburg, responds: A distinction must be made between pre-retirement capital within a retirement annuity, pension or provident fund and post-retirement capital within a living annuity or guaranteed life annuity.
The extract from Retire Right refers to a rule that applies only when you convert your pre-retirement capital into an annuity.
The law does not provide for splitting your post-retirement annuity. Some providers allow you to have a composite annuity, which makes a portion guaranteed and has a portion that gives you an investment return. The only way to move your living annuity from your current provider is by way of a section 37 transfer to a new provider, but the fund must be moved as a whole.
Although there is an advantage in having a predictable income from a guaranteed annuity, there are a few important considerations to take note of:
• Any amount converted to a guaranteed life annuity can never be converted back to a living annuity, so you cannot change your mind later.
• You cannot adjust the underlying assets of a guaranteed annuity.
• A guaranteed annuity leaves no capital for your heirs, unless it has a built-in life insurance policy that will cost you extra. However, you can buy a guaranteed annuity that will enable your spouse to continue receiving a portion of the income on your death.
• A guaranteed annuity might reduce your volatility risk, but, over the long term, a much greater threat is the risk of your investment not growing enough for the income to beat inflation.
• The income a guaranteed life annuity pays you is based mostly on prevailing interest rates, so an important consideration is what your real (after-inflation) growth will be.
• The average inflation rate is six percent, but many pensioners experience a much higher inflation rate, with some monthly expenses, such as health care, increasing by more than 10 percent a year.
• Research has found that living annuities have out-performed guaranteed life annuities in the long term more than 80 percent of the time, depending on the economic cycle.*
Please obtain advice from a qualified financial adviser to ensure you make the right decision.
* Editor’s note: This research comes with a health warning from both the author and the authors of opposing research published in Personal Finance in July last year.
What tax will I pay if I rent out my home on Airbnb?
What are the tax implications if I let out my primary residence on Airbnb? If I add the rent to my income, can I claim the upgrades to the residence as a tax deduction?
Tim Milner
Kari Lagler, a tax consultant in private practice, responds: Any rental income arising from letting your property, whether it is your primary residence or a second property, must be included in your income for taxation.
You are, however, entitled to deduct certain expenses against that rental income. These expenses include rates, water and electricity, insurance and security. If only a portion of the property is let, the expenses should be apportioned, for example, based on the area let as a percentage of the total.
When it comes to “upgrades”, the deduction will depend on whether the expense qualifies as a repair or as an improvement. A good test for whether an expense is a repair is whether the property has been damaged or has deteriorated compared to its original condition. The expense is a deductible repair if it returns the property to its original condition.
Note that only repairs and expenses in relation to the portion of the house that is let are allowed as a deduction. The area must be regularly and exclusively used for letting in order to qualify.
Expenditure that results in an improvement to the property is regarded as a capital expense, and you are not allowed to deduct it against the rental income. You are, however, allowed to add it to the original cost of the property, and it will reduce the capital gain when you dispose of the property. Adding a room or a balcony or a swimming pool are examples of improvements
Another issue to consider is the primary residence exclusion, which exempts the first R2 million of the capital gain when the property is sold or otherwise disposed of. The exclusion must be apportioned if you rent out your primary residence. This will require a calculation to apportion the gain and the exclusion pro rata to the total area and the number of days let to the total days the property was held.
How can we make sure that our retirement capital lasts?
My wife and I have two living annuities, one valued at R2 million and the other at R250 000. Our home is paid off. Both of us are in very good health, and we expect that our capital will have to last for 20 years. How much should we draw down to make it last that long?
RD James
Graham Lovely, a financial adviser at PSG Wealth in Rondebosch, Cape Town, responds: Assuming an annual growth rate of eight percent and an inflation rate of six percent, you could withdraw about six percent a year, which, initially, would translate into about R11 000 a month. Your capital will be depleted after about 25 years. If you increase your drawdown to seven percent a year, or about R12 700 a month, you are likely to deplete your capital after 20 years. If your drawdown is 8.5 percent, or R16 000, your capital will last about 15 years. I have ignored the tax implications on your annuity income, so these rates may be a little overstated.
Studies have shown that if you want to protect yourself against running out of capital in virtually any circumstance over a period of about 30 years, you need to start with a very low withdrawal rate, of four percent or less.
It is important to optimise your asset allocation. Growth assets require more time to overcome the inherent volatility in returns in order to provide good growth. Certain investments are better at providing income (yield). An appropriate balance between investing for growth in the long term and capital protection in the short term must be achieved.
It is important to note that sustainable withdrawal rates are typically lower when assets are more expensive than normal (when the 10-year price:earnings multiples for equities are high and bond yields are low), and are higher when assets are priced at below-average values. Considering that the former is currently the case, and given the outlook for the next decade, you are advised to be conservative when deciding on your initial drawdown rate, rather than using past returns as a guide. If you are fortunate to experience a period of low inflation and high investment returns, reward yourself with a sustainable increase.