How can I invest R5m to generate R20k monthly income for 22 years?

Dear reader,

The most important investment decision you will make is how to invest these funds. With any investment where you are making a regular income withdrawal, the investment strategy becomes of critical importance because you not only need to outperform inflation, but also your monthly withdrawal amount. This way, you can ensure your capital will last as long as possible.

Firstly, I would recommend following a very well diversified strategy, especially in a high inflation environment as that we are currently experiencing.

Short-term income needs should be invested in cash and bonds. These asset classes will provide short-term stability through market cycles, but the expected average returns will also be lower, especially with the current inflation environment being at a high it hasn’t been in years.

Growth assets (equity exposure) get included from here onwards. These are funds you will typically only touch four or five years down the line, ensuring sufficient time for equities to recover should there be a downturn in the market. Growth assets consist of equity, property, local and offshore exposure. This is the asset class providing returns over the longer term of CPI+6%, CPI+7%.

The strategy will not only be very important initially when structuring the investment, but also to sustain you as you start drawing an income. Rebalancing the asset classes/underlying portfolios will be required as time goes on to ensure the initial investment strategy is sustained.

Taking inflation of 6% into account for this scenario, and working on an average return of CPI+6% to CPI+7% for the portfolio, the withdrawal rate to ensure your capital will last as long as possible (hopefully more than 22 years), will be 5%.

Your income requirement comes very close to this: 5% on R5 million = R20 833.33pm.

Should you draw this percentage, your capital will not deplete should inflation stay within the assumed range, and should the portfolio reach the expected return over the longer term. Any higher withdrawal will start eroding the capital much quicker.

If you do not wish to include this investment in your retirement planning 22 years down the line, you can opt to start withdrawing a higher income and essentially start depleting the capital. This assumes you are certain that you are making sufficient provision towards retirement and that your retirement requirements will be met. Otherwise this can supplement your retirement income wonderfully.

Keep in mind these funds will have an impact on your overall net tax effect as you are now earning a higher income.

I would recommend using your existing retirement portfolio to counter the increased income earnings.

On these types of funds (discretionary funds), you also need to be on the lookout for additional tax levied for the interest earned. This will be on the interest bearing portfolios (cash and bond exposure), as well as capital gains tax (CGT) on the equity exposure of the portfolio.

As rebalances and withdrawals will be happening often, tax implications need to be taken into consideration as well. Tax in this instance at least means that your portfolio earned a positive return – which is a good thing!

CGT is triggered whenever an investor sells units. You are not liable to pay CGT simply because your investments grew in a particular tax year. You realise a capital gain or loss on unit trust investments only once you sell the units (known as withdrawal or repurchase). This includes: switches between funds; transfer of an investment (or part thereof) to another investor other than a spouse (referred to as a ‘change of beneficial ownership’); emigration or death of an investor (unless you have made provision for your units to be transferred to your surviving spouse; or you transfer them to a registered public benefit organisation).

If you remain invested in the same unit trust, you could avoid paying CGT for as long as you remain in that fund.

Investors should be careful, however, not to lose sight of their overall investment goals and objectives when considering ‘deferring’ CGT. CGT is merely one aspect to consider as part of your investment decisions. The Income Tax Act provides that a taxable capital gain or loss must be included in the taxable income of a taxpayer for the year of assessment. The taxable capital gain is calculated in terms of the rules contained in the eighth schedule to the act and will be determined by calculating the difference between the original cost (base cost) and the market value of the units at the date of sale.

Individual taxpayers who make a capital gain will be able to exclude R40 000 of any gains in the particular year of assessment and the inclusion rate is 40%.

Interest paid to the investor will form part of the income tax liability. For individuals below 65 years of age, the first R23 800 of interest received is exempt and R34 500 is exempt for individuals over 65 years.

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