Retiring early and spending the rest of your life doing what you like ... it's everyone's dream. But it can be a reckless gamble, if you take the plunge without planning. Three members of the Financial Planning Institute explain the risk of stepping off the treadmill too soon.
Currently, only 10 percent of South Africans retire with enough money to live on for the rest of their lives, even at normal retiring age. So early retirement is a prospect for very few.
The risk is that you think you can afford it, and then a few years down the line you find that inflation has left you with just too little money to maintain your previous lifestyle, Andre Jacobs, one of our Financial Planning Institute (FPI) panellists, says.
If you are hoping to quit before retirement age, there are three key questions to ask yourself, according to Giselle Gould, another member of the FPI panel:
* Have you saved enough already to maintain your lifestyle for the rest of your life?
* Do you understand the tax implications of early retirement? and
* Can you afford to take a tax knock?
If you cannot answer yes to all three questions, then early retirement is not a realistic option for you.
It depends on your profession
Your chances of having a comfortable early retirement differ according to your profession, Kobus Engelbrecht, the third member of our panel, says.
You cannot retire before 55 if you earn a salary and belong to a retirement fund. You can resign, but you will be penalised by the taxman. Only the first R1 800 of your retirement fund money will be tax free and the rest will be taxed at your average tax rate. On the other hand, if you hang on until 55, at least the first R120 000 of your retirement fund money is tax free.
If you are a farmer, you probably do not have a retirement fund. Your plan is probably to pass the farm on to your son or daughter. But then where will you live and on what income? Can the farm support you and another family?
You should plan well in advance and if possible avoid putting the extra burden on one farm, Engelbrecht says.
If you are a professional person, such as a lawyer or a doctor, you probably intend to sell your practice and use the proceeds as your retirement capital. If you are a business owner, you probably intend to sell your business. You may think that this is sufficient and that other investments are unnecessary.
But anything could happen and at the time you sell, your business or your practice may not be worth as much as you hoped. And your mid- to late-50s is no time to start planning, Engelbrecht warns.
An acquaintance of mine who is a businessman wanted to retire at 50. He's in his mid-40s and it looked possible. But suddenly his main customer went bankrupt and now, instead of retiring, he's struggling to keep his business going at all, never mind selling it to finance his retirement.
The message, Engelbrecht says, is
Start planning early
Sit down with a qualified financial planner, someone who knows his or her stuff, and put a plan into practice. Don't try to be too exact with the figures. If you're planning 25 to 30 years ahead, you have a lot of assumptions to make about inflation, economic growth and so on. We can't predict what the world will look like in 25 years time ... we don't even know what it will look like tomorrow.
Save as much as you can - you can never have too much money.
But there is no point in living miserably now in the hope that you will retire rich - you have to strike a balance, Engelbrecht says.
How can you plan for early retirement?
It depends how much time you have, Jacobs says.
If you have 10 years to go before you want to retire, he suggests you follow these steps:
* Work out how much you will need at retirement in terms of income and expenses;
* Determine what will be available from your own savings, your retirement fund and other sources of income; and
* See if there is a shortfall or a surplus: If, as is likely, there is a shortfall, you can work out a savings target and start aiming for it now.
If you only have one year to go, you must follow the same steps (being painstakingly accurate in calculating your income and expenses), but if there is a shortfall you will not have time to save. You will either have to cut down on your post-retirement expenses or find other sources of income.
Double whammy
Bear in mind that if you retire early you will be hit by a double whammy, Engelbrecht warns: Not only have you stopped earning sooner, so there is less money available to live on, but you are also going to have to support yourself in retirement longer than if you had retired later. So you have got less time to save and more time to live on your savings.
Try to plan for a surplus, he suggests. If you think you need R10 000 a month, try to get R15 000 or R20 000. Try to prepare a cushion for when you really get old.
Spread your risk by spreading your investments on retirement, Gould advises. Use a combination of annuities, stock market investments, unit trusts and the like, and monitor your investments carefully.
Because your money will need to last longer, you will have to be even more careful with investment choices than someone retiring at the usual age, Jacobs says. You will want to get as much return on your investments as possible, but at the same time you will not want to take unnecessary risks.
And pay off your debts before making any investments: That is a rule that applies to anyone, but especially to people considering retirement. Paying off the home loan before you retire means you can live, free of worry, in your own home.
Medical complications
In retirement you will have to meet additional health care costs. Everyone hopes for a long and healthy old age, but the fact is that most of your healthcare spending will take place in the last years of your life.
And it is hard to plan for this, Engelbrecht says, with doctors' fees and medical scheme payouts changing all the time.
Medical scheme costs have increased at a rate far exceeding the normal inflation rate, Jacobs says. You need to make sure that in your calculations you have provided sufficiently for healthcare expenses. I would also suggest you make sure that the medical scheme option you have chosen does meet your needs.
And, he says, try all avenues to stay healthy, giving attention to all aspects of your life: Hobbies, exercise, diet, family and other relationships, and your lifestyle.
Taxwise, it is smarter to work until you are 55. And if you work until you are 65, you get further tax advantages, including deductible medical expenses.
The taxman cometh
But you may be so keen to get off the treadmill that you are prepared to take the tax knocks. Or, of course, retrenchment or ill-health may leave you no choice.
If you are retrenched, up to R30 000 of your salary, retrenchment package and retirement fund money is tax free. Salary, retrenchment package and leave pay will be added together first and only if the total comes to less than R30 000 would any retirement fund money be considered for exemption, Gould says.
If you do not transfer the money from your retirement fund into a preservation fund or other retirement fund, but withdraw it, you will be taxed in the same way as if you had resigned and only the first R1 800 will be tax free.
Once you have made the decision to retire early, you probably will not be able to go back on it.
As soon as you have decided to quit your retirement fund, for whatever reason (ill-health, retrenchment, resignation) and a tax directive has been issued by the fund, it becomes virtually impossible to change your mind, Gould says.
Termination of membership of a retirement fund or a retirement annuity fund is hard to reverse. A retirement fund has eligibility requirements which cannot be met once you are no longer in an employee-employer relationship.
In the case of a retirement annuity policy, you may only exit at age 55, or for reasons of ill health. The policy is then terminated. If you want to change your mind about early retirement, you will have to enter into a new contract and start a new policy.
Be sure of your decision
If you've sold your business or your practice, you won't be able to reverse that decision, Engelbrecht says. But you may be able to work as a consultant, especially if you have good qualifications and experience. And psychologically, anyway, it's probably better not to stop working completely. You should have an interest until you die.
The sum you've set aside for retirement may look huge; be assured, it is not.
If you're salaried, sums like R1.5 million probably look enormous. But if you're 55 years old, R1.5 million is not much to live on in retirement, and if you're 50, you probably can't afford to retire on R1.5 million, Engelbrecht warns. Don't be bamboozled by the noughts on the figures.
TAX TIPS
1. If you retire at 55, you can take, tax free, the greater of either: the first
R120 000 of your retirement fund money (all retirement funds added together) or R4 500 multiplied by the number of years you have been contributing to a fund, Kobus Engelbrecht says. The rest of your retirement fund money is taxed at your average rate.
2. Put your retirement fund money into a preservation fund if you can. Use other money to live on. At the latest, you must take out that money when you are 69 years old. So just before your 69th birthday, make a once-off withdrawal - you will pay your average rate of tax and you will have been able to ensure that it is at its lowest that year.
THE FPI EXPERTS
The Financial Planning Institute (FPI), formerly the Institute of Life and Pension Advisers, was formed in 1982 to improve the standard of financial advice. Members must pass stringent examinations and abide by a code of conduct, and the institute's Generally Accepted Planning Practice.
Kobus Engelbrecht
has a BA LLb, and an MBA. He is an advocate and holds the Certified Financial Planner qualification from the FPI. He has worked at Boland Bank, Southern Life and Old Mutual and is now marketing manager at Sanlam Personal Finance.
Giselle Gould
graduated with a B.Sc Med. from the University of the Witwatersrand before deciding she would prefer finance to medicine. A Certified Financial Planner, she worked for Liberty, Old Mutual and Momentum before taking up her present position as executive head of the Institute of Retirement Funds. She is now completing her MBA.
André Jacobs
has a B.Admin from the University of Pretoria. He is a Certified Financial Planner and holds the FPI qualifications in life assurance, pensions and health, as well as risk management. He is on the executive committee of the FPI and is the research and development manager at Absa Healthcare Consultants.
This article was first published in
the 2nd Quarter 2001 issue of Personal Finance magazine. See what's in our latest issue