Balancing income and growth

Albie asks: My mother is 84 and still healthy. She lives in a retirement village. She is a widow and receives a pension of R6 000 and has a very good medical aid with no contribution. The pension covers her accommodation and then she still had a little bit left. She has saved approximately R200 000 in Absa’s Moneymarket or Builder.

The children inherited the house and she received a rental income of also R6 000 from the house. So her total income per month was about R12 000.

The house has now been sold and within the next few weeks we will receive approximately R850 000. She will obviously receive the income from that money. We (the children) thought of forming a trust, otherwise my tax will be too high.

A financial adviser proposed that two-thirds of the money is saved in a traditional financial institution so that she can get as much interest as possible, an emergency fund of about R40 000 and the remainder at say Allan Gray, the Balanced Fund or something similar, but conservative.

My questions are:
1. Her own money, the R200 000—shouldn’t we consider to put some of it in Government Retail Bonds and if so, for how long?
2. Do you agree with the advice of the adviser? We do not want to take major risks with the money.
3. Shouldn’t we take say a R100 000 and invest it in a higher risk fund or the Top 40?
4. She usually managed to save up to a R1 000 per month, but I am not sure if it will still be possible. She saved that money into her own account.

Maya replies: This is such an interesting question because it is almost identical to my mother’s situation so I am going to answer this question from personal experience.

Trusts are not always ideal
Firstly think twice about a trust. We have actually moved the money out of a trust because it was such an administrative hassle. Now the money is in her name and her will stipulates that the proceeds go to the capital beneficiaries on her death.

She receives the income in her own name so we have no tax obligations. Given that the estate duty exemption now sits at R3,5-million, estate duty is not a problem. As capital growth is not the priority it is unlikely there will be significant capital gains tax—at least not enough to justify the costs of a trust.

High dividend income portfolios
My mother’s money is invested in a high dividend income fund managed by an independent portfolio manager.

It has a good spread of bonds, preference shares, property and high dividend shares and is managed to minimise tax on interest income whilst providing an income that increases with inflation.

She has received a stable income increasing in line with inflation despite the market crash in 2008 and the capital has grown in line with inflation since 2006 when we invested it.

This strategy ensures that she receives a tax-effective income as well as growing the capital because even at these low inflation rates the real value of her capital would fall by 5% every year if it was just invested in cash and she was drawing out the full interest payment.

Dividend and interest income from property increases over time keeping up with inflation. As many pensioners have discovered, interest rates can fall and do not keep pace with inflation.

Alternative optionsTax is not such a major problem in your mother’s case because as a pensioner she can receive R32 000 of interest income a year tax-free and would not pay income tax on the first R88 528 of income. In total she could earn R120 000 before paying tax.

However, some exposure to property and high dividend shares would preserve the capital value and ensure that her income kept pace with inflation. If she is only drawing down on the income and not the capital, any movements in the underlying value of the investments would not affect her.

The proposal by the financial adviser seems sound as she will live off the interest of the two-thirds (R560 000) and the investment in the balanced fund will hopefully grow and offset the inflation loss. However at current interest rates she will only receive around R2 800 per month and if anything, interest rates are set to go lower rather than higher. Can your mother afford to take such a major drop in income?

You may find she needs to invest the full amount for maximum income in a diversified fixed income portfolio.

Marriot asset management is the only fund management company that focuses only on income solutions so I had a look at their offering.

As an example the Marriot High Income fund currently has a yield of 8,72%. If she kept R50 000 of emergency cash and invested R800 000, this would provide her with income of R5 800 a month.

This fund, however, has no growth assets so ideally she would only draw down 6% at most (R4 000) and re-invest the remainder to at least allow some growth of the capital so that her income can also increase each year.

As this fund invests in bonds and other variable fixed-interest instruments the capital value can fluctuate in the short-term but the focus should be on the income.

She could also consider a high dividend income fund, for example the Marriot Prudential Income Fund has a yield of 4,91% but has exposure to both local and offshore equities providing for some growth. In this case she could draw the full income of R3 000 a month; however ,unlike a bank deposit, the income should increase with inflation.

Her own savings:
I would agree that she should not try to save R1 000 a month but rather take a lower income from the lump sum so that it can keep up with inflation and therefore increase her income by inflation each year.

The RSA retail bond has a great interest rate but she must be comfortable locking it away for two years. If she has R50 000 of emergency money and she has no immediate need for the R200 000, then that may be a good idea. She can also withdraw the money early, although she will forfeit interest.

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