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Retirement Planning
Thursday, October 1, 2009
Coping with burdens

The burden of excessive debt, a weak savings culture together with a lack of investment knowledge and discipline: such habits leave many South Africans unable to accumulate enough capital for retirement during their working years. In addition, the increasing life expectancy of the average person, as well as the rising cost of living, further reduces the likelihood retiring financially independent.

Comments Johan Gouws, Executive Director at Absa Investments, “The amount of capital required for income purposes after retirement are often underestimated.
“When planning for retirement the key elements to consider involve the individual’s planned retirement date, life expectancy, medical expenses, inflation and the required standard of living.”
For example, an individual who retires at 65 on an annual income of R500 000 with a need for 80% of the final monthly salary and who lives another 25 years after retirement, will need approximately R8 million in capital at retirement.
In order to cover any shortfall, individuals are left with the options of working longer than originally planned, taking on more investment risk for greater returns, saving for longer before retirement or a combination of all three.

The Solution

He says the ability to retire comfortably is a function of how much has been saved before retirement, the time allowed for savings to grow and the return achieved on the savings. “Starting your contributions as early as possible in life, saving as much as possible from your monthly and/or other income combined with the appropriate exposure to riskier asset classes to beat inflation, should provide a sound base for achieving financial independence,” he notes.
The first aspect to consider is the appropriate vehicle through which to save for retirement. Gouws explains that retirement savings can be accumulated as part of a formal retirement scheme of an employer in the form of a pension or provident fund, or through additions to a retirement annuity, or through contributions to a discretionary savings plan. “Linked retirement annuity funds offer a flexible and cost effective retirement solution when looking to make additional retirement contributions,” he suggests. Over and above tax-deductible contributions, investments in the retirement annuity do not attract income or capital gains tax on any investment build up. No tax is payable on transfers to a retirement annuity.

“The next aspect to consider is the allocation of investments between different asset classes. Generally the longer the term to retirement the more exposure should be maintained to riskier asset classes such as equities and property. These have proven to be the most effective inflation beaters over the long term.”
Prudential investment guidelines allow for a maximum exposure of 75% to shares when investing through retirement vehicles. It is, however, important to diversify the investment across all asset classes and to allocate a portion of the investment to international assets in order to reduce investment risk in a portfolio. Diversification can also be achieved by investing with different asset managers as they have different investment philosophies and strategies. Liquidity, choice, tax efficiency relating to capital gains as well as low minimum investment requirements have made unit trusts a savings mechanism of choice through which portfolio diversification can be achieved.
A final, but important, element to consider is the power of compound growth as this determines the level of contributions required up to retirement. The table provides an illustration of what impact the term during which regular contributions are made has on the amount of capital available at retirement.
Note that figures shown in the table assume a starting contribution of R500 per month that escalates by 6% every year and a 10% investment growth per annum.

Discipline is required to allow as much investment capital to grow for as long a period as possible. From 1st March this year, when moving from the Pension Fund of one employer to another, the member is allowed a tax-free withdrawal of R22 500 as well as a larger withdrawal that is taxed on a sliding scale. Gouws says the current financial environment is making withdrawals prior to retirement for the purpose of settling short-term debt extremely attractive. “However, once calculated, the eroding effect of tax together with the opportunity cost of not harnessing the power of compound growth argues strongly against such a decision. An alternative to moving retirement savings to another pension fund is the tax-free transfer of assets to a preservation fund.”

Copyright © Insurance Times and Investments® Vol:22.10 1st October, 2009
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