How discretionary investments can enhance your retirement income plan

Most South Africans used their pension, provident, and retirement annuity (RA) funds to save towards their retirement. But while these investments offer attractive tax benefits, they also come with rules that can limit flexibility and access, as well as exposure to certain investment assets. That’s where discretionary investments can make all the difference. 

People predominantly save within their employer’s retirement funds through compulsory investments. Often, they forget about discretionary investments and the role those can play both pre- and post-retirement. Discretionary investments are long-term investments made with after-tax money.

Ensuring multiple streams of income post-retirement

In South Africa, the National Treasury estimates that only 6% of working people can retire comfortably. Against this backdrop, compulsory investments alone are unlikely to meet your post-retirement needs. Instead, a discretionary savings plan can help build a larger nest egg while offering greater flexibility and income longevity in retirement.

Money for when life happens

Discretionary investments are not ‘locked in’ until retirement and could provide a valuable source of funds for unexpected expenses. No plan is ever perfect, and life does happen. In retirement, your discretionary savings can provide you with emergency access to a lump sum or a higher income for a few months. That’s not possible in the compulsory income space, where compulsory post-retirement products don’t offer total flexibility of income.

Infinite choice

Discretionary investments also offer a broader choice of investments – including greater access to offshore funds. Retirement funds are bound by Regulation 28, which aims to protect savers by enforcing diversification and caps on risky assets (75% for equities, 25% for property, and 45% for offshore exposure). While these limits help to reduce the chance of large losses, they can also constrain higher-return or more globally diversified strategies. Because discretionary investments are not bound by Regulation 28 in the pre-retirement phase, you can tilt your portfolio to opportunities – like offshore assets (either through local products or direct offshore products), hedge funds, structured products, and so on – that suit your goals and risk tolerance.

Be tax savvy

Another key consideration is tax: although you’ll no longer be working when you’re retired, you’ll still pay tax on your income. That’s why tax planning becomes even more important post-retirement.

In retirement, how you combine withdrawals from living annuities and discretionary investments can meaningfully reduce the tax you pay on your income. Income from your living annuity is fully taxable at marginal rates. By reducing the drawdown from that annuity product (within the 2.5% to 17.5% band), while topping up with income from your discretionary investments, you could see a substantial difference in the pre-tax income needed from your total retirement savings, to ensure the same income after tax.

This, can help you avoid moving into a higher tax bracket in a given year and support a more stable after‑tax income. Most of the time, retirees can get the same after-tax income by combining discretionary and compulsory sources, drawing a lower combined pre-tax income rather than a higher pre-tax compulsory income from annuity products.

Higher-yielding assets within a discretionary investment could also cause tax to be paid on the interest generated above current exemptions (R23 800 below age 65 and R34 500 above 65). Over time, holding these higher-yielding, tax-inefficient instruments inside retirement products and tax-free accounts, where returns are tax-free, could improve after-tax returns. Keeping more tax-efficient and growth assets in discretionary accounts could also improve the income generated from the retirement plan.

Retirement income that lasts

One of the biggest concerns for retirees is the sustainability of their retirement income, especially as life expectancy rises. Active management of compulsory and discretionary income could mean making your income last longer in retirement. It can also create opportunities to transfer more wealth to the next generation.

Combining compulsory income with discretionary income is a very involved process and needs active management. It should preferably be done with the help of a knowledgeable financial planner and be revised at regular intervals to get optimal results.

* Human is the business development manager at Glacier by Sanlam.

PERSONAL FINANCE