In the world of financial planning there are numerous “wisdoms” that gets shared which is probably not that wise, simple or even true. I would like to address four of those so called “wisdoms” today:
Wisdom No 1: “No investment beats a retirement annuity (RA’s) as the Receiver of Revenue is “helping you save” at your marginal tax rate”
This statement only holds true if the individual making the contribution to the annuity will be reinvesting the refund into another investment. In practice this unfortunately happens seldom. The tax refund, when received, typically disappears into a (sudden) expenditure abyss. The asset allocation within a RA is also restricted in terms of Regulation 28 of the Pension Funds Act which means that in theory the returns on RA’s would be between 1% – 2% less when compared to a 100% investment into equity and listed property (locally and abroad). If you don’t invest the tax refund you will end up with an eventual lower value instead of the intended increased retirement value. To add insult to injury, the amount at retirement that is invested for an income (after the one third allowed withdrawal which is also subject to the retirement tax table) is included in your taxable income.
Plain and simple, you have to invest the tax refund offered by the Receiver of Revenue to maximize the benefit of this structure. The most effective way of achieving this is to ask what you can afford to contribute to a retirement annuity, to instruct your payroll administrator to already incorporate the tax refund and to then increase your total contribution by this amount. By means of example if you are earning at 41% marginal tax rate and can afford to invest R5 000 then your eventual contribution should actually be R8 475.
Wisdom No 2: “You must continue with your life insurance after retirement, because you cannot just throw all the payments into the water which you made through all the years”
A generous dose of logical judgement is required as to what the intention of life cover is. Apart from ad hoc costs such as liabilities or estate duty tax, the primary intention is to provide an income to the surviving dependents (spouse or children) which typically falls away when no income is earned anymore by the insured life. An effort to sustain the life insurance premiums whilst in retirement can seriously derail the overall investment plan. To continue with life insurance premiums within retirement (or in cases where a passive income is earned) only makes sense in the following scenarios:
In cases where a calculation indicates that the value of the combined premiums and resultant value of the insured benefits carries a high probability to render better results than an alternative investment would. This is very seldom the case
Where you can accept that the premiums will be paid throughout, even if the insured life grows very old. If this route is taken you have no other choice but to see the plan through to the end as the potential loss in premiums increases as time passes.
If there are costs or liabilities that would create liquidity constraints within the estate
If you do elect to go this route, make very sure about the premium pattern that is chosen as an aggressive pattern that increases exponentially more than the cover amount will become unaffordable over time.
Wisdom No 3: “Your house is your greatest asset”
Yes and no. If you are not careful your most loved asset can become a financial noose around the neck. You often hear the story where people are told to buy the most expensive house they can afford as the bond installment will remain the same over time and that the value of the property will grow from day one. The problem with this logic is that the type of house often dictates the rest of your spending behavior. With a fancy house comes fancy furniture, fancy holidays, fancy vehicles and eventually a fancy retirement village where you barely have any spare change left after selling your primary property. Let me put it like this, I have rarely seen your “greatest asset” at retirement making a material difference to someone’s lifestyle or longevity of their capital pool.
People are typically just not willing to downscale from their R6 million house in Stellenbosch to a R1 million retirement house in Putsonderwater and to live happily ever after on the R5m profit. In planning terms we refer to your primary residence as a lifestyle asset and do not included it in our retirement projection or planning, because you will always need a roof over your head. You would be well off by applying the same logic. By the way, you a probably not doing your children a favour when helping them financially to buy a property that they cannot afford to pay from their own salary, but more on this on another day.
Wisdom no 4: “I should be “okay” financially as I am a member of my employer’s retirement fund“.
There are several problems with the perceived comfort that retirement funds, with risk cover, offers through an employer:
Although most firms allow for generous compulsory contributions one must remember that the accumulated capital does not pay out in a tax friendly manner. The income drawn from the compulsory living or life annuity is fully taxed (due to the contributions being tax deductible) and as such you would need a much bigger pot compared to someone that is drawing an income from a discretionary pot of capital which was saved with post-tax money.
Risk benefits (death and lump sum disability) as a factor of yearly fund salary is typically totally inadequate to replace the life insured’s salary.
The death benefit offered within funds are often “approved” cover as opposed to “unapproved” cover. First mentioned is taxed according to the death and retirement tax table before the final payment is made to beneficiaries which means the effective cover is significantly less than you think. Please confirm with your human resource division whether your fund includes approved or unapproved benefits and make sure your financial planner uses the correct values in their calculations
Although all possible care was taken in the drafting of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone planning on taking any financial action based on this document, is strongly advised to first consult with their personal financial advisor. ProVérte Wealth & Risk Management is an authorised financial service provider with FSP no. 5966.