Which Investments Should You Draw From First in Retirement?

Which investment should pay for your retirement spending next? It's tempting to just pick the account with the smallest tax bill, right? It seems like the obvious choice.

But, well, the tax impact is really only part of the decision. We also have to ask ourselves, what money can you actually access, what existing commitments does it need to meet, and what future flexibility are you going to have left over? there isn't some universal rule out there that says every retiree has to spend cash first or leave tax-free investments for last. A truly useful withdrawal plan connects your actual household spending with your income, your specific accounts and your payment dates.

You always want to start with the money that's already flowing into your accounts. Things like a pension or life annuity payment might already cover a good chunk of your budget. If you have rental income, you need to factor in a realistic allowance for expenses and potential vacancies.

And this is absolutely vital. You must use net income after a realistic tax provision, instead of just treating every gross payment as money you can go out and spend. If you're receiving income from a few different sources, separate tax deductions might not cover your final combined tax bill.

Oh, and if you're in a shared household, remember that each partner's ownership and tax position still needs to be considered separately. Let's imagine a practical scenario. A household is spending 480,000 rand a year.

Their dependable income, after making an appropriate total tax provision, provides 360,000 rand. So that leaves us with a gap of exactly 120,000 rand for the year. But here's the key takeaway.

That is the amount of spendable money required. It's not automatically the amount you should just go and request from a taxable income source. You see, before you even start comparing taxes, you have to check access.

Think about it. A bank balance might be subject to a notice period, or maybe it's already reserved for taxes and emergencies. An investment sale takes time to settle.

A living annuity provides income based on its own specific rules. It's not just unrestricted lump sum capital. You've got to check the income election dates and policy conditions before relying on a change.

And just because a certain income level is permitted, well, that doesn't prove the capital can actually sustain it. Guaranteed pensions follow their contracts, and property or business values, that's a different story altogether. An asking price is definitely not cash in the bank.

Sales have to complete and costs and taxes have to be accounted for. So simply put, an account that can't supply the money when the bill actually falls due won't solve an immediate funding problem. Let's compare a few ways to supply that same 120,000 rand.

Now keep in mind, this is just an illustrative one-year comparison, not a recommended withdrawal order. We're assuming the routes we're looking at are accessible in time, and our investment sale figures here ignore transaction charges, though you'd obviously include them in real life. Okay, so spending 120,000 rand of your existing cash principal gives you that amount without a new income tax charge, simply because it's principal being spent.

However, the interest earned on your cash might still be taxable, and depleting that reserve really matters. Alternatively, taking 120,000 rand from a qualifying tax-free investment also supplies the cash without tax on the withdrawal, but doing that reduces the money permanently sheltered in that account. Putting it back later counts as a new contribution, subject to annual limits.

The withdrawal doesn't just magically create an equal amount of replacement contribution room, so that future flexibility is something you really have to weigh alongside today's tax bill. A discretionary investment sale works a bit differently. The entire amount you sell isn't automatically a taxable gain.

For this specific example, please carefully note these exact assumptions we're using to set our baseline. We assume the investment is held on capital account and that the gain represents exactly 25% of the sale proceeds. We also assume a 40% individual inclusion rate that the annual capital gains exclusion has already been used elsewhere, and that there are no available capital losses.

Finally, we assume the extra taxable gain falls entirely within an assumed 36% marginal tax bracket, and that there are no transaction charges. We're keeping these specific assumptions together purely for this illustration. This is not your personal tax position.

Let's walk carefully through the math here. For an individual, 40% of the relevant net capital gain is included in taxable income. working with our specific assumptions, taking the 25% gain multiplied by the 40% inclusion rate and multiplied again by the 36% marginal rate that makes the extra tax exactly 3.6% of the proceeds. To conclude the calculation, if you sell approximately 124,481 rand, you are left with 120,000 rand after providing for the illustrative tax.

The tax provision itself is about 4,481 rand. It is absolutely not a flat tax of 36% on the entire sale. Keep in mind, changing the base cost, having available exclusions, or adding capital losses would completely change this result.

And if your calculation happens to cross a tax bracket, applying one marginal rate to the whole additional amount just won't give you the correct answer. Also, be aware that additional taxable annuity income requires a completely different calculation. You have to do a full income incremental tax calculation.

You work out the extra tax using your full income and the relevant tax rules, and then determine the gross payment needed to leave you with the required cash. You definitely do not simply apply an investment sale percentage to an annuity payment. You also need to confirm that the proposed payment is actually permitted and assess what effect it will have on your remaining capital.

Neither tax efficiency nor a permitted drawdown establishes that the withdrawal is sustainable. The whole comparison becomes a lot more useful when we give the remaining money a specific job. Suppose your household’s 120,000 rand cash balance is actually your only reserve for urgent repairs, a medical excess and a tax settlement.

If you spend it entirely, you completely remove that vital protection. In a case like that, a suitable investment sale might actually be preferable, even with its tax cost. On the flip side, if you have genuinely uncommitted cash, it might make an additional taxable withdrawal unnecessary.

It really just depends on the specific circumstances. Record two different balances for each of your accounts, one balance for what can technically be withdrawn, and another for what can actually be spent after covering your existing commitments. Then look at the investments you're leaving behind.

Remember, a tax-free account is just a tax structure. It doesn't describe your investment risk. It could hold cash or it could hold growth assets.

If you choose your withdrawal solely based on the account's label, you might unintentionally warp your household's overall investment mix. Now, a cash reserve can definitely reduce the need to do an immediate sale right after a market fall, but it doesn't guarantee the market will recover and it doesn't remove investment risk. A reserve that gets spent repeatedly is going to need a replenishment policy.

You have to decide how you're spending, your reserves, and your portfolio will be reviewed together, instead of just hoping markets will bounce back before your next bill is due. You really need to map this out on a calendar. Mark down your income dates, annuity election dates, settlement periods, annual bills, and tax payments.

Once you do that, you'll quickly notice how a December expense simply cannot wait for an income change that only takes effect in March. Any gap or bridge like that needs to be identified well before you place your instructions. I highly recommend comparing your practical alternatives side by side.

Think about keeping existing income unchanged, arranging a discretionary sale, considering a tax-free withdrawal, or making a permitted annuity income change. For every single one of those options, look closely at the net cash, the remaining reserves, the investments that are left behind, and the administration involved. And of course, always revisit your plan whenever there's a change in your income, ownership, health, or family circumstances.

Ultimately, your goal is to have a withdrawal plan that you can comfortably explain, account by account, and date by date. It has to fund the life you need today, while carefully considering the choices you might need tomorrow. Please do remember, this explainer serves as general South African financial education.

It is not a personal withdrawal instruction. Read the full article in the ClearGauge Financial Library. A financial clarity review can examine all these linked decisions for you, with the scope and a once-off fee completely agreed upon before any work begins, and with absolutely no obligation to change your current advisor.