In the sixth article in our series on the Old Mutual/Personal Finance Retire Right seminars, Peter Stephan, the manager of marketing services at Old Mutual, advises you on how to plan for retirement if you are five to 10 years away from that big day.
Financial advisers are frequently asked, "What is a good investment?" in the hope that they will provide the investor with an answer that will lead to instant wealth.
But retirement planning cannot be done in a vacuum. What makes financial sense for one person is not necessarily good for another, Stephan says.
Instead, you should ask a financial adviser to conduct a proper financial needs analysis for you. The four ingredients to a financially secure retirement are sufficient time, sufficient input into your chosen plans, diversification through appropriate asset allocation, and discipline.
To achieve this, you need to take stock of your current situation without delay and then implement a plan by choosing one or more investment vehicles. It is unlikely that your companies' pension fund will provide you with sufficient retirement funds.
Some of the most common investment vehicles for retirement are: unit trusts, retirement annuities, endowments, managed portfolios, provident funds, and pension funds.
While the above all have their place, there are, however, various criteria you can use for choosing a vehicle. These include: how liquid the investment is (the relative ease with which it can be bought or sold); whether it comes with any guarantees; the term of the investment; the regulations that apply to the investment; the cost of the investment; what happens to the investment at your death; and what happens to the investment should you be declared insolvent.
For instance, the total value of your life assurance policies are - subject to certain conditions - protected up to R50 000 from creditors, while retirement annuity (RA) funds are fully protected from your creditors should you become insolvent.
Each investment vehicle can invest in one or more portfolios. These include: specialist equities; general equities; interest-bearing instruments; property; and local or offshore investments.
You should select an investment according to such criteria as: the risk and return offered by the investment; when you invest; when and how the investment company reports on the investment; and inflation.
Withdrawal options
It is important to preserve your retirement fund money should you leave your job. If you quit your job, you can do one of the following:
- Take your retirement fund proceeds in cash, in which case you will be taxed on the full amount less the first R1 800;
- Transfer your money, tax-free, into a preservation fund (which can be a pension or a provident fund, depending on the fund from which you are withdrawing). A benefit of a preservation fund is that, if you structure it correctly, you can make one withdrawal before retirement;
- Transfer your money, without paying tax, into an RA with a life assurance company. You will not have access to the money until you are 55 years old;
- Leave the money in your retirement fund and become a deferred pensioner. You will get a monthly pension from your old fund when you retire. Depending on how long you have to go to retirement, a possible consequence of this option is the loss of control over your money, limited flexibility and investment choice.
An advantage to you is lower costs;
- Transfer the money, without paying tax, into your new employer's pension or provident fund - but only if the rules of both funds allow it; or
- Choose a combination of the above options. An RA/preservation fund combination is quite popular because of the flexibility it provides.
Tax-planning Strategies
You need to do tax planning before and after retirement. Some tax-reducing strategies need to be implemented well before retirement, so don't wait until you actually retire.
The rate at which you will pay tax on the cash pay-out by your pension fund and an RA is based on your average tax rate in the year you retire or that of the preceding year, whichever is greater.
Before retirement, you can reduce your average rate of tax by:
- Retiring late in the tax year of your final year of working, so that the previous year's income (usually less than current income) is taken into account when calculating the tax on your retirement sum;
- Claiming all taxable deductions;
- Ensuring that your RA and preservation fund mature after you have retired;
- Postponing income due to you - such as share options and deferred compensation plans - until after you retire;
- Postponing income due to you in the last two years of employment. For instance, you can transfer an endowment into the name of a trust. You can donate up to R30 000 tax-free every year to the trust, which pays premiums on the endowment. Before retirement, you can borrow from the trust so that you have money on which to live. The loan from the trust is not regarded as income.
After retirement, you can reduce your tax liability by:
- Claiming all medical expenses (including medical scheme contributions) from tax if you are 65 and over;
- Making the most of the interest exemption which allows people 65 and older to pay no tax on the first R10 000 of interest earned;
- Understanding the type of annuities available. There are differences between a conventional annuity (which stops paying when you die) and a living annuity (in which the balance of the investment can be left to your heirs). Living annuities do not come with any guarantees and you carry the investment risk;
- Buying a voluntary annuity with the one-third tax-free lump sum you get from a retirement fund may be more favourable from a tax point of view; and
- Taking into account estate duty in which your estate will pay tax on the lump sums but not annuity streams.
Other articles from the seminar: