If you want to retire right, you need to select the financial services products that match your stage in the retirement life cycle. Andrew Bradley, chief executive of ipac South Africa, which provides core services to select financial advisers, set out the product options at the Personal Finance/Old Mutual Retire Right seminars held recently around the country.
There is no magic formula for choosing the right investment products which will give you massive returns, Andrew Bradley says.
The key to successful investment is best described by US investment expert, Warren Buffett, who said: "To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework."
Bradley says investors often fall prey to their emotions, making an investment decision at the top of a cycle and bailing out at the bottom.
To get your retirement investments in order you have to follow "lifestyle financial planning".
To select the correct investment vehicle you need to follow a five-step plan. These steps are:
1. Your lifestyle (investor profile)
Your investor profile for retirement is affected by many factors, including the assets you own; your available income; your liabilities (debts); your spending; your income requirements; your tax profile; your dependants; and your time horizons (years until retirement/the years you expect to live in retirement). These factors must all be listed.
2. Investment returns
You need to decide on the investment return you require to maintain your lifestyle. This also means deciding on the time period over which you wish to meet your investment targets. If you have little time you may require greater returns or the returns you require may be lowered if you have more time.
3. Asset allocation
You need to decide on the type of assets in which you need to invest to achieve your required return. There are four basic asset classes: shares, cash, bonds and property.
4. Risk assessment
You need to assess the investment risks you are prepared to take. Bradley says one way to do this is the eat well, sleep well judgment. If you want to eat well (in other words take high risks to achieve big returns), you may not sleep well; but if you sleep well you may not eat well by not taking some investment risk.
5. Correct investment vehicle
In choosing the correct investment vehicles for retirement you must consider four factors at all three stages of investment, namely going in to the investment, during the investment period and coming out of the investment. The factors are: costs; taxation; flexibility; and security.
There are nine investment vehicles from which to select for your retirement savings. These are:
Hard Assets
These are such things as coins, carpets or even aircraft. Bradley advises against the use of hard assets for retirement savings. Unless you are an expert, they are difficult to trade. Hard assets should be lifestyle investments you enjoy.
Pension funds
Pension funds are pooled investments made available by employers to employees. The funds invest money on your behalf in shares, cash, bonds or property. Costs are charged on an on-going basis. You can take one third as a lump sum with the balance as a monthly pension.
The income tax implications of a pension fund are pre-tax money going in; during the investment period the income received by the portfolio is taxed at 25 percent; and on maturity you are taxed on the lump sum (which you only receive once) above a threshold of R120 000 at your average rate and on the pension at your marginal rate. There is a three-year moratorium on capital gains tax (CGT) for retirement funds.
Provident funds
Provident funds are pooled investments made available by employers to employees. The funds invest money on your behalf in shares, cash, bonds or property. Costs are charged on an on-going basis.
Unlike a pension fund, you can withdraw the entire amount as a lump sum without buying a pension.
Member contributions are after tax going in, while employer contributions are pre-tax; during the investment period the income received is taxed at 25 percent; and on maturity you pay tax above a threshold.
Retirement annuities
A retirement annuity for investment purposes works in much the same way as a pension fund with your money being put into pooled portfolios. The retirement annuity fund holds the assets on your behalf.
You can only mature a retirement annuity at age 55 but it must be paid out before the age of 69. You can take one third as a lump sum with the balance as a monthly pension. You can be invested in any combination of shares, cash, bonds or property.
The income tax implications of a retirement annuity are pre-tax money going in; during the investment period the income received by the portfolio is taxed at 25 percent; and on maturity you are taxed on the lump sum above a threshold of R120 000 at your average rate and the pension at your marginal rate. There is a three-year moratorium on CGT for retirement annuities.
Preservation funds
Preservation funds can only accept transfers from pension or provident funds, with the rules of the fund from which the money has come applying to the preservation fund investment.
The preservation fund holds the assets on your behalf and can be invested in a combination of shares, cash, bonds or property. Costs are applied on an on-going basis.
You may make one withdrawal from a provident fund before retirement age with the first R1 800 tax free and the balance taxed at your average rate of taxation. At retirement you are taxed on the same basis as a provident or pension fund.
Life assurance endowment policies
Your money is pooled together with money from other investors. The pools are called portfolios which offer different investment options, combining shares, cash, bonds and property. The life office owns the assets, promising you a payment after a fixed period with a minimum investment period of five years. Most of the costing is up front.
The income tax implications of an endowment are after tax money in paying your premiums; during the investment period the income received by the portfolio is taxed at 30 percent; and on maturity there is no tax payable. From October 1 CGT will be paid within the portfolio on your behalf.
Unit trusts
Again these are pooled investments but unlike endowments the fund holds the assets in trust on your behalf; you have total flexibility in the investment and the costs are paid on an on-going basis. You can be invested in any combination of shares, cash, bonds or property.
The income tax implications of a unit trust are after tax money is used to make investments; during the investment period the income received is taxed in your hands (except local dividends); and on maturity there is no income tax payable. You will have to pay CGT from October 1.
Wrap funds/linked products
A linked investment company provides an administrative umbrella through which you can either invest at your discretion in a number of underlying investments, such as unit trust funds, or without your discretion through a wrap fund, where a wrap fund manager decides for you on the underlying investments, which again are mainly unit trust funds.
You can be invested in any combination of shares, cash, bonds or property. You own the assets, the investment term is flexible and the costs are charged on an on-going basis.
Investments are made with after tax contributions; income flows during the investment term are taxed at your marginal rate of taxation; and there is no income tax payable when you withdraw the investments. You will have to pay CGT from October 1.
Compulsory/living annuity
Compulsory annuities (pensions) that must be purchased with two thirds of the value of a retirement fund, including a retirement annuity, come in various forms. With a life assurance traditional annuity you have various choices. You pay a lump sum to a life assurance company which in turn provides you with a pension for life.
The pension can take various forms, such as being increased every year to take account of inflation, and can continue the payment to your heirs if you die before a fixed period of, say, 10 years. Your money is pooled and is invested in shares, cash, bonds and property and the insurer carries the risk. The life office owns the assets.
With a living annuity the responsibility for receiving the investment returns to provide you with a pension lies with you even though the assets are owned by the underwriter. You own the assets. You must draw down a pension of between five and 20 percent of the annual value of your investment. You make the selection of the underlying investments. Living annuities as such are not high risk but the underlying investment choices you make can be risky.
Your contributions to both types of annuity are tax neutral. During the investment period there is no tax paid on any growth or income generated, but you are taxed on the income you receive.
THE IMPACT OF COSTS
Costs will have an impact on your investments, Andrew Bradley says.
You must be prepared to pay costs to have your investments properly managed, but, at the same time, you should be aware of what costs may do to your investment returns.
Here is an example of how costs of five percent would impact on an investment of R1 000 a month; showing a 15 percent a year growth on a five, 10- and 25-year investment period. The amount you will receive from your investment is shown in the table below:
Up frontOn-goingNo cost
5 yearsR83 360R85 197R89 681
10 yearsR252 015R264 724R278 657
25 yearsR2 660 911R3 119 870R3 284 073
This indicates the different results of deducting the same costs upfront or on an on-going basis.