While government provides taxpayers with excellent incentives to invest through approved retirement funds, the uptake remains critically low, and the overwhelming majority of South Africans remain severely underfunded for their retirement years. Although many employed South Africans have the option to invest through their employer’s pension or provident funds, with unemployment being at an all-time high, this option has become available to fewer people. Retirement annuities, which are personal retirement funds not linked to occupational retirement funds, make attractive investment vehicles, particularly for those who are self-employed, whose employer does not provide retirement benefits, or for those who want to supplement their pension or provident fund savings.
Modern retirement annuities are unit trust-based, fully transparent, and provide investors with complete flexibility when it comes to choosing an investment strategy, albeit within the ambit of Regulation 28 of the Pension Funds Act. As with all approved retirement funds, investors can save up to 27.5% of their taxable earnings into an approved retirement fund on a tax-deductible basis, up to the annual maximum of R350 000. Besides the tax benefits of investing with pre-tax money, investors enjoy additional benefits in that no CGT, dividends withholding tax, or income tax on any growth earned within these funds, meaning that investors benefit from the compounded tax benefits over the long term. However, to benefit fully from such structures, it is important to start early, consistently invest enough for your goals, invest appropriately, and avoid dipping into your retirement savings. Simply put, the best time to start saving is right now – and if you’re still waiting to save, consider the following case study which demonstrates the cost of delaying your investment journey.
Consider the case of Ayanda
Ayanda is a 25-years old and earns an income of R35 000 per month. For the purposes of this exercise, we have assumed that her income will keep pace with annual inflation until she retires. She’d like to plan for a comfortable retirement at age 65 that will allow her to draw a post-retirement income of R25 000 per month, which is approximately 70% of her pre-retirement income in real terms. Ayanda asks her financial advisor to help develop a tax-efficient retirement plan for her. As Ayanda is relatively young, her advisor builds a life expectancy assumption of age 100 into her financial plan. Given her 40-year time horizon, her advisor knows she can invest more aggressively and, as such, assumes that her investments will achieve returns of inflation plus 4.5% per year (net of all fees) during the accumulation phase. At retirement, Ayanda will move her invested capital into an investment strategy that targets annual returns of inflation plus 4%, net of all fees. Anna decided that she would begin contributing 15% of her monthly income towards the chosen investment strategy and that these contributions would increase annually in line with inflation.
Scenario 1: Ayanda begins investing with her first pay cheque
Anna sets out her investment journey with her first pay cheque by contributing R5 250 per month (15% of her pre-tax income) towards her retirement fund. She continues consistently on this investment path, increasing her contributions annually in line with inflation until she retires age 65. Her disciplined savings allow her to retire comfortably at age 65 drawing after-tax income in retirement of R24 000 per month.
Scenario 2: Ayanda begins investing 10 years later
Ayanda decides not to implement her retirement plan and only revisits her retirement planning when she reaches age 35. At this point, she begins investing 15% of her pre-tax income into an investment strategy targeting annual returns of inflation plus 4.5% net of all fees. However, because she delayed the start of her investment journey, she is only able to draw an after-tax income of R15 500 per month from her invested capital from age 65, which is only 62% of her retirement income objective.
Scenario 3: Ayanda begins investing at age 45
In this scenario, we have assumed that Ayanda gets caught up in her career, marriage, and raising children, and puts off her retirement savings journey until she reaches age 45. She decided to begin investing 15% of her pre-tax income towards the inflation plus 4.5% strategy. However, with a reduced investment horizon of only twenty years, Ayanda is only able to draw an after-tax retirement income of R8 250 per month from age 65, which is 33% of her retirement income objective.
Incidentally, if you invested a lump sum of R450 000 into a retirement annuity for a child born in 2023, that child would be able to retire at age 65 years drawing an after-tax retirement income of R25 000 per month in today’s terms – which just goes to reinforce the power of compounding interest.
If you haven’t started saving for retirement, all is not lost as there are several options available to address the shortfall. Naturally, delaying the age at which you retire is the most obvious option, although there are risks involved in doing so particularly when it comes to your health and employability later in life. While you may have every intention of delaying your retirement, keep in mind that many illnesses are a function of old age, and you need to factor in the reality that illness can thwart your plans to keep working. The second option available is to save more although, with a fixed income and a limited time period in which to achieve your goals, this may not be financially possible.
Another option available to you is to take on more investment risk although, before doing so, it is important to understand what this means for your investments. With a significantly reduced investment horizon, keep in mind that exposing your capital to greater investment risk means tolerating short-term market volatility which may be difficult to stomach as you draw closer to your retirement date. Finally, a workable option is to reduce your post-retirement budget so that you are aiming for a smaller target. While none of these options on their own can be considered a silver bullet, employing a combination of all four options may provide you with a chance of achieving a financially comfortable retirement.
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