Should my mother take early retirement or resign to access her full pension?

One possible strategy is for her to resign, preserve the retirement fund, and then transfer it into a living annuity.

My 56-year-old mother, a teacher, is considering early retirement. The early retirement programme (ERP) package offers two weeks’ salary (R20 000 gross) per year for the first 20 years and one week’s salary for the next 14 years, though it’s unclear if she can withdraw a one-third lump sum of R1 309 842.17 before tax.

If she resigns, she could access her full fund value of R3.4 million, but this would incur significant tax. What would the estimated tax be, and which investment options could provide stable income and preserve capital? She needs R350 000-R500 000 immediately for a car and an emergency fund.

She prefers resigning for greater control, but would like guidance on the pros and cons of both options and which would be most suitable.

Dawn Ridler

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Deciding to retire and turning one’s investments into an income/pension is a huge decision, and frankly requires a much more in-depth analysis of a client’s needs than can be gleaned from the few variables provided.

It is not only unwise but against Financial Advisory and Intermediary Services (Fais) regulations for any advisor to give advice without a full understanding of the client and their long-term needs, so please excuse me if what I mention below is vague and general.

Decisions made at this point often cannot be reversed, so it is very important that you and your mother get professional advice as soon as possible.

Before getting into some of the nitty-gritty of the options, I would suggest that the early retiree garner a very good understanding of her retirement income needs. (I have a RedFile [AI] organisational system that includes balance sheet and income statement templates – free on request).

ERPs (if they are properly structured as a severance benefit) are usually taxed at retirement fund rates, but they will erode the tax-free lump sum. Going on the limited details provided, it looks like the ERP would pay out around R540 000 – which would use up the tax-free lump sum – but could then be used to fund the car and emergency fund.

Read: Treasury slashes early retirement costs Why the last 10 years before retirement matter most

I am not sure why you think that the full pension will be taxed – this would only happen if she were to cash it in (using vested rights prior to the two-pot system). I do not recommend this.

Just based on the information provided, I would potentially recommend that your mother ‘preserves’ the retirement fund (by resigning rather than retiring – as long as it doesn’t impact her ERP), and then ‘retires’ from the preservation into a living annuity once she has a clear understanding of her future income needs (these can happen almost back to back and there is no increased cost).

There are some very important considerations, and perhaps a greater understanding of the fund rules and the tax implications of retirement savings before any professional would be able to give advice on the best way forward.

Read:
Ten costs that may rise in retirement
The ‘perfect’ retirement lump sum: A costly mistake?
Protecting your retirement income: How long can a downturn last?

Because of her relatively young age, and the reality that she may need this income, rising with inflation, for 40 years, it is very important that the living annuity be prudently drawn down (a maximum of, say, 4.5% per annum) and invested in a cost-effective, decent performance, low-fee environment.

Unfortunately, R3.4 million is not enough to replace her current income, growing with inflation indefinitely (before tax – annuities are taxed as income too).

At a 4.5% annual drawdown, she would need approximately R21 million to get a monthly income of R40 000.

This is why it is so important for future retirees to have a good understanding of their future, family, and income needs.

If your mother is alone and has no other sources of income, then the dramatic decrease in income is going to come as a huge shock. If she has a partner who is still working, or has a decent pension, then less so.

Can you see why there is never a one-size-fits-all answer?

Bottom line, I strongly recommend that your mother speaks to an independent financial advisor before making any decisions, and that they come up with several solutions and recommendations. (This is not going to make me popular – but if the advisor wants to charge an upfront fee as well as an ongoing fee – as they are ‘allowed to’ – then look elsewhere.)

Read:
How much is ‘enough’ for retirement?
Retirement annuities: From tax deductions to the two-pot retirement system
More than numbers: What a true financial plan should deliver

Age 56 is very young to retire, and she could easily live another 40 years, and the income produced will have to grow with inflation (with medical aid inflation treated separately) over that entire period, with capital appreciation to ensure that happens.

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