Retirement planning is all about making informed decisions. At the Old Mutual/Personal Finance Retire Right seminars, Kenneth van Zyl, the director of Advance Wealth Management, explored the options open to those who are more than 15 years from retirement.
Planning for retirement involves considering numerous options and time is on your side when you are young.
There are several ways you can save money and several ways to access that money.
You can use a pension or provident fund, retirement annuities, or a combination of all three to save.
Once you retire, you can access your money as a lump sum or monthly, in the form of an annuity or pension. Alternatively, you can live off the interest from a savings account.
If you start saving from the day you start working, time will work to your advantage in the following ways:
- Flexibility. You will have the time to accommodate changes to your plans or lifestyle. You will need to consider changes in inflation, taxes, medical costs, investment costs and any other hiccups.
- Investment choice. Certain investments, such as unit trusts and the share market, work better over the long term. Over the past 25 years, the JSE Securities Exchange's All Share Index has provided investors with returns of 22 percent, but over the past seven years investors on the JSE have had a bumpy ride.
- Tax rates. These are reducing from year to year and different taxes affect your investments, depending on the way you save your money.
- Compound interest. This works to your advantage over the long term. If you save R1 000 a month for 25 years, escalating the amount by seven percent a year, and at an interest rate of 11 percent a year, you will have R2.6 million in 25 years. And you will have contributed only R800 000. Tax is not considered in this calculation.
- Time and rand-cost averaging. Time reduces the risks that you take in the short term. You benefit from rand-cost averaging when you invest on a regular basis. When you invest every month in a pension fund or investment, the prices of the underlying investments (such as shares or unit trusts) vary. Over time, the average cost of a regular investment is lower than the average cost of a once-off investment, Van Zyl says.
Tax implications
The taxation of investments will influence your choices when it comes to how you want to invest. Some investments can be made with pre-tax money, while others can only be made with post-tax income.
Pre-tax investments are instruments such as provident funds, pension funds and retirement annuities.
After-tax investments are home loans, property, endowments, shares or unit trusts, income plans, money market or fixed deposits, offshore investments and hedge funds.
Contributions to pension funds and retirement annuities are tax-deductible up to a limit.
Your contributions to a provident fund are not tax-deductible but you can take the entire amount as a lump sum when you retire. The contributions that you made to the fund are not taxed at retirement.
You can save up to 40 percent on tax by contributing to a pre-tax saving vehicle, Van Zyl says. For example, if you earn more than R240 000 a year, every rand above that amount is taxed at 40 percent. If you invest your money in a pre-tax saving instrument, such as a retirement annuity, the whole amount is invested.
If you invest money in an after-tax instrument, such as a basic savings account, you will pay 40 percent tax on the income, leaving only 60 percent of your money in savings.
If you resign, you can move your pension fund money from your employer's fund to your new employer's fund, without having to pay tax.
All pension funds are taxed at 25 percent. If the tax rate on your investment savings is more than 25 percent, then you save on tax by putting your money in your pension fund.
When you retire, you are entitled to withdraw a once-off lump sum from you pension fund, part of which is tax-free. The balance of the lump sum will be taxed at your average tax rate.
If you transfer your pension into an annuity fund, the transfer is tax-free. But the monthly pension you receive from the annuity fund is taxable.
Paying tax now or later
If you invest R1 000 in a pre-tax vehicle for 25 years, with your contribution escalating by seven percent every year and the investment earning you an 11 percent return, you will save over R2 million.
By contrast, R1 000 invested in an after-tax savings instrument at a tax rate of 38 percent (assumed marginal rate) will save you R1.5 million after 25 years, assuming your contribution escalates by seven percent a year and the investment earns you 11 percent interest every year.
The trend of decreasing personal taxes bodes well for future tax rates, Van Zyl says. When comparing the tax rates of 1995/6 to 2002/3, there has been an annual 4.5 percent reduction in annual tax rates. If you are paying the top marginal tax rate of 40 percent now, you may well be paying less tax at retirement, so it will be worth your while to defer taxation by investing in a pre-tax retirement fund.
Time and the cost of tertiary education
Tertiary education costs increase every year. One way to provide for these costs is to use your home loan. When you pay extra money into your home loan, you can later access the capital to cover study costs. When you repay this withdrawal, it will be at the interest rate you are charged on your home loan, which is generally the cheapest form of loan there is. You will also have saved some interest on your loan while the extra payments were still in your loan account, before you accessed it for education costs.
The cost of investing
Charges on investments will also affect the eventual outcome.
Remember that there are exit and ongoing fees on investments. A high upfront fee and low ongoing fee is cheaper than a low upfront fee and a high ongoing fee.
Capital gains tax and your investments
Pension and provident funds, preservation funds, retirement annuities and living annuities are all exempt from Capital Gains Tax (CGT) for three years from the introduction of CGT in October 1, 2001. This exemption may be extended.
Tips for investors
- Stay informed by reading newspapers and talking to people.
You need to be able to identify opportunities in the market and
avoid pitfalls.
- Invest within your own risk profile. The younger you are, the more risk you can afford, but the closer to retirement you are, the more conservative you should become.
- Diversify your investments. Do not invest all your money in one product.
- Be realistic and reasonable in your expectations. Your investments will grow over time, not overnight.
- Be disciplined. Don't spend all your money so that you do not have any to invest. At retirement, make sure you can access your money. The point of a retirement plan is to take care of your financial needs at retirement and not to leave a legacy for your heirs.
- Seek professional advice and communicate with your adviser frequently.
- Review your plan on a regular basis. Make cost comparisons and monitor your investments.
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