Di Turpin, the chairperson of the Association of Unit Trusts and external relations manager at Old Mutual Unit Trusts, discussed the fundamentals of retirement planning at a recent meeting of the Franklin Templeton NIB Investments/Personal Finance Investor Club in Cape Town. Charlene Clayton reports.
Even after a 30-year working life, your pension is likely to be 40 percent lower than the last salary you draw - and if you have worked for a shorter period of time, you face an even greater income gap when you retire.
Di Turpin, the chairperson of the Association of Unit Trusts and external relations manager at Old Mutual Unit Trusts, says the average length of employment is 15 years, and people who have worked this long will have a 70 percent gap in their incomes when they retire.
It is vital that your retirement planning takes into account the income gap that you are likely to experience after retirement.
You should think about augmenting your retirement savings to take account of this gap. Otherwise, you must be prepared to dramatically downscale your lifestyle after you retire.
When planning for your retirement you also need to take into account that, with healthier living and access to medical care, if, as a man, you reach the age of 65, you can expect to live to 78; as a woman, you can expect to live until the age of 82.
If you plan to retire early - and many people would like to retire at the age of 55 - you will have to factor in additional years for which to plan financially.
Apart from the income gap and the age at which you wish to retire, other factors that you need to take into account when drawing up your plan include:
Choice of pension vehicle and medical scheme
Your choice of pension vehicle will depend largely on whether you are self-employed or an employee.
If you work for a company, you would generally be able to join either a pension or a provident fund. Each works differently and has different tax implications prior to and after retirement.
Retirement annuities are voluntary investments and provide a means for self-employed people to save for their retirement, or for employees to augment their com-pany pension plans.
If you retire early or leave the services of your company before the age of 55, you can transfer your pension savings into a preservation fund. By law, you are not allowed to draw your retirement money before the age of 55.
At retirement, you have the choice of a living annuity or a traditional annuity in which to invest your retirement savings. However, some company pension funds do not allow you to buy a living annuity, so it will depend on the rules of your current fund.
A living annuity is more flexible than a traditional annuity and your capital doesn't "die" with you, but can be left to your heirs.
With a living annuity, you can draw down between five and 20 percent of the capital every year. But one of the big dangers is that the investment growth does not keep pace with your withdrawals. The result is that you run out of capital.
With a traditional annuity, you "buy" a monthly annuity for life. The life assurer takes the risk that you may out-live your capital.
Health
You need to take into account the following issues:
* Medical scheme benefits: It is important to check with your medical scheme what benefits you will receive after retirement and to make provision for any gaps in your medical cover;
* Your family's history of illness: Even if you are healthy now, if your family has a history of, say cancer, you should bear in mind that you may also get cancer and you need to consider the impact of this on your finances; and
* Claiming pattern: You need to consider what you currently spend annually on medical costs and to bear in mind these costs are likely to escalate as you grow older.
Risk
Risk is a very important aspect of retirement planning. Take the minimum of risk with your retirement savings. The shorter the time you have before you retire, the fewer risks you can afford to take.
Lifestyle
Consider the lifestyle that you would like to lead after retirement. Factors to bear in mind include whether you will remain in your present home or downsize to something more manageable. Consider whether a retirement village or an old-age home is suitable for you.
When buying into a retirement village, make sure you understand the implications of the sale contract. Also, bear in mind that you may have to put down your name early if you want to buy in a worthwhile scheme.
The possibility of requiring nursing care is also important.
You should settle these issues while you are still young and healthy as it will make it easier to reach a decision later in life.
Lifestyle trends
Trends in lifestyles may affect the way you spend your retirement. For example, the "African family concept" - where the family unit lives on one property for security, financial or social reasons - is gaining in popularity.
You need to consider the possibility that you or your children may move overseas. You must plan for the costs that will be incurred if you wish to visit your family.
If you plan to live outside South Africa, remember that any pension bought in this country will be paid out in rands. Thus the exchange rate of the rand against the currency where you plan to live is also an important consideration.
Protecting your retirement savings
It takes a long time to build up retirement savings and if you are changing jobs you should consider preserving your retirement money. There are four options for preserving retirement funds:
* The best option, if your present fund allows it, is to leave your money in the fund. In this case, you won't have to pay re-investment costs. Before choosing this option, check with your fund as to which benefits you will be entitled;
* The next best option is to transfer your retirement savings to your new employer's fund. Often this can be done without incurring investment costs;
* You can also invest the money in a retirement annuity; or
* Transfer the money to a preservation fund where you can park your money until retirement age. You are allowed to make one withdrawal from a preservation fund, but remember not to use it unless you plan to pay off debt, such as your home loan.
Estate planning
Your estate will have to pay estate duty when you die, and this will leave fewer assets for your heirs. The first R1 million of your assets is exempt from tax and you will pay 25 percent on the balance.
Apart from taking into account the tax you will have to pay, you must make provision for any cash flow problems that having to pay the tax will cause. Sometimes estates have to sell assets to cover cash flow problems and the most liquid assets are not always the best ones to sell.
You need to consider the implication of the introduction of capital gains tax (CGT) in October. However, the new tax should not cause you undue stress.
There are various ways in which you can minimise the estate duty. These include:
* Splitting assets between spouses so that both benefit from the R1 million abatement;
* Divesting assets directly to children, but retaining the right to use those assets; and
* Using trusts. The advantages of trusts are: The assets you have transferred to a trust are not considered part of your estate; the flow of income is not affected (when the breadwinner dies, the partner is often left without an income until the estate has been settled); and they speed up the settlement of an estate.
A financial needs analysis
A financial needs analysis is your lifeline to a successful retirement plan. It identifies your needs and goals, your retirement targets, the needs of your dependants and what you can afford. It also helps you structure your medium- and long- term plans and clarifies your lifestyle goals.
How much do you need?
You need around 70 percent of your last salary as income after you retire. The reason is that by retirement you should have paid off large debts, such as your home and car loans, and you will probably downscale your home so you don't need quite as much money as when you were working.
You should have a capital base of 10 to 20 times your annual salary to provide you with the income you require after retirement.
Many people forget that the money you earn from an annuity is taxable. If you pay the marginal rate, 42 percent of your monthly income will go to the Receiver.
You don't need a fortune to build the required capital base, but you must start saving early to get the full benefit of compound interest.
The benefits of compound interest may be illustrated as follows: John puts away R200 a month from the age of 25. By 55, John, will have invested a total of R72 000 and the value of his investment will be more than R412 000. In contrast, James starts investing 10 years later at the age of 35, and puts away R500 a month. James will have accumulated only R120 000 and his investment value will be only R359 000 at the age of 55. These examples assume the investments grew at a rate of 10 percent a year.
A financial plan
A financial plan for retirement is essential. There is no magic formula or investment that will help you reach your retirement goals because there is no single plan that will suit everyone.
Everyone's personal circumstances are different - depending on their age, earning capacity, dependants, health, lifestyle, risk tolerance and tax status.
Your financial plan should include three legs: Now; 10 years' time; and retirement.
Your plan must include a cash flow plan to cover emergency needs, an income plan and an asset plan. When drawing up your plan, consider the worst possible scenario. Think about what would happen if you got divorced, your spouse died, you were declared insolvent or your health took a turn for the worse.
Evaluate and put down on paper:
* Your debts;
* How much life cover you have;
* How much group life cover you have through your company;
* Your pension, provident and preservation fund investments;
* Your retirement annuities;
* The value of other assets, such as unit trusts, money market accounts, art collections, paid off properties; and
* The maturity date of your investments (so that you know when the money will start coming into your portfolio).
You can put your financial adviser on the right road as to the type of product you require for a portfolio or tackle your financial plan jointly with a financial adviser if you don't feel confident about going it alone.
When considering investment products make sure you check out the following:
* The contribution amount;
* Your expected returns if it is a guaranteed product;
* All the costs;
* Any ongoing costs; and
* The full implications of taking advice to cancel any of your existing investments or move them into other vehicles.
You should evaluate your financial plan at least one a year or when you have a major change in your personal circumstances. For example, the birth of a baby, or divorce.
Tax planning
Ensure that your retirement plan is tax effective by making use of all the tax deductions available to you during the building up of your retirement savings and after retirement. For instance, the greater of 7.5 percent or R1 750 can be deducted off your salary every year for tax purposes.
A portion of what you pay into a retirement annuity can also be deducted for tax. The amount is the greater of 15 percent of non-pension fund taxable income, or R3 500 minus your pension fund contributions, or R1 750.
Other tax allowances include:
* The R1 million estate duty allowance;
* A tax-free interest income allowance of R4 000;
* Individual tax abatements; and
* Using your lower marginal tax rates where applicable for CGT calculations.