3. How to live on interest income if interest rates decline

Question 

I have money in the bank that I use to provide me with an income.  

I am finding it difficult to make ends meet because of the decreases in the interest rate.  

What do you suggest I do 

Answer 

Interest rates have decreased by 3% this year.  This may not seem like a big number but when you put it in context, it has had a devastating impact on people living off their investments. 

If  you had R1 000 000 in a fixed deposit earning 7% at the beginning of the year, you would have received R70 000 in interest.  At the moment, you would get 4% interest on a fixed deposit so you would receive R40 000 a year.  This is little over half of what they were receiving at the start of the year. 

Living off a bank deposit is not always the best way to provide a pension for yourself.  Bank deposits do not beat inflation over the longer term.  This is important as we are living longer and if our capital is not invested correctly, we can end up in a situation where our income cannot fully support us. 

There are two products that I recommend to my clients as alternatives to using bank deposits to provide a pension 

•  voluntary annuities
• discretionary income plans.

Voluntary annuities provide you with an income for life in exchange for a lump sum payment .  There are a number of types of annuity that you can purchase. You can choose one that gives a flat income or one which increases with inflation.  You can even choose an annuity which pays your spouse a percentage of the annuity should you die. 

Voluntary annuity rates are currently very attractive.  Last year, R1 000 000 would have bought a 65 year old woman a CPI linked annuity of R5 300 a month.   If she bought the annuity today, she would get R7 000 a month.  

In the case of a man, the annuity would be R7 700 a month because men do not live as long as women.  If no annual increase was chosen, the R1 000 000 would provide a 65 year old man with a monthly annuity of R10 300.   

When you compare this with the income you would get from a bank deposit, this income is very attractive. As the annuity is  guaranteed, you will not be exposed to interest rate fluctuations. The downside is that all the capital would be used to purchase this annuity. There will be no cash for the heirs to inherit 

Voluntary annuities are also tax efficient.  Most of the monthly annuity payment is deemed to be a repayment of capital.  In the example above, only R4 200 of the R10 300 would be taxable.  On the other hand, the interest income from the bank would be taxable. 

An alternative to voluntary annuities is a discretionary income plan.  Here the individual would invest a lump sum and draw a monthly amount every month.  The ideal situation is to have the investment growing by more than the drawdown.   The challenge here is to structure the investment properly to ensure that this happens. The mistake that many make is that they put all the funds in a conservative portfolio. While this will protect the capital and provide an income, the lack of growth elements could create problems in the future 

The ideal investment is one that protects  and grows the capital over time and allows one to draw a regular income.  To enable this, I split these investments into three pots.  An amount to cover a year’s worth of income would go into a money market account.  I would then put a portion into a low equity portfolio and the balance into a higher equity portfolio.  Every year we would rebalance these portfolios to ensure there is enough in the money market fund to provide an income 

The advantage with this structure is that the investment will provide long term growth as well as an income. This structure is also tax efficient with much of the income coming from capital drawdowns as opposed to interest income which is taxable. 

Banks provide capital security but are not great for providing inflation beating returns or a tax efficient income.  If you have money in a local or offshore bank, it is important that you understand what you are wanting to achieve with it. It is usually better to speak to a specialist who can put you in a purpose built vehicle to help you get the outcome you want. 

Kenny Meiring MBA CFP ® is an independent financial adviser. You can contact him on 082 856 0348 or at Financialwellnesscoach.co.za