Retirement is seen as a stage in your life where you can live off the investments you have accumulated over your working career. In these modern times where people are living that much more longer we need to revalue our financial freedom. It doesn’t have to be 65 and can be much earlier if you take control. Realistically, it probably will be much later.

The big question is how much do you need to set aside for my future financial freedom and the answer lies close to the proverbial “How long is a piece of string?”

There are some guidelines which have been established in financial services over the years which are certainly not exact and conclusive but let’s share them and see how they may help.

The 15% Rule

This percentage is bandied around as the starting point for savings for your future. Pension funds tend to use this percentage as the contribution level for their members. This provision is more realistic the earlier one starts to save but as you get older the amount becomes less significant.

For example: If you start at age 20 earning R15 000 your 15% savings is R2 250 per month.

Saving to age 60 which is 40 years will arrive at an amount of R12,5 million. Starting at 30 with the same amount will arrive at an amount of R4,6 Million. Staring at 40 will arrive at an amount of R1,6 million.

So it is clear that the amount of time over which you save is significant.

Formula

Another way to assess how much you need is to divide your annual income requirement at retirement by a factor of 0,05.

If you need R15 000 multiply this by 12 and then divide by 0,05 which amounts to R3,6 million.

Multiple of your monthly income need

240 times your monthly salary is a way to assess how much you need. Say you earn R15 000 per month then this multiplied by 240 is the amount you need at retirement which amounts to R3,6 million.

Capitalisation

Financial planners calculate the amount required by capitalising on the income needed. Taking into account inflation -return – time. A monthly income need of R15000 for a 15-year period amounts to R3 470 695. This amount will change significantly if any of the variables are adjusted. So one should adjust to it by frequently reviewing your savings performance over time.

Whichever way you look at it your savings need to be reviewed frequently to see how they are performing in line with your future financial freedom. Keep close and don’t underestimate the fact that we are living longer.

Yes, it is really important we understand that we need to save for the future. One day, someday, we will need to rely on our own investments to maintain our lifestyles. It’s just the way the world works. We spend most of our lives working to get through the demanding cost of living which increases systematically into the future. At some point, your retirement savings will be all that you have to rely on for the rest of your life.

There are many ways to save for your financial future. Many would have you believe that you should invest in a retirement annuity in the first instance as it is the investment of choice for retirement. Not necessarily. Here are some reasons why:

You can only access your RA at 55      

Young investors have to provide for many financial events during their working careers – getting married, buying and house and car, having children and educating them. A retirement annuity won’t help you along the way. The access to funds is very limited to death or only a third in cash when you get to 55. So, when starting out on your savings program the focus should be on the accessibility of your funds. More appropriate options are money market accounts and unit trusts which can be accessed at any time when needed.

Your tax rate is low  

One great benefit of a retirement annuity is that you claim back the contributions made in every tax year. The money you get back is relative to your tax rate. If you pay 45% tax then you get 45 cents back for every rand invested. However, if you don’t pay tax because your income is below the tax threshold of R78 150 then there is no benefit to investing in a retirement annuity. As there is a tax applied to the retirement annuity at retirement it is probably better to invest in other alternatives until your tax rate moves up the tax scale.

Your cost of debt is more than 30%

If you are spending more than 30% of your income on paying off debts then you need to get this area of your financial planning under control before locking up your savings in a retirement annuity. The cost of debt is probably way higher than the returns you get in a retirement annuity. So in the short term to medium term rather work down your debt and get it under control before committing to a long-term retirement annuity. There is an argument that compound interest will catch up over time but there is a practical reason to pay off your debt sooner than later. The cost of the debt is high and if you get into financial trouble you could lose your asset. So ensure that you are well on top of debt before embarking on a long-term retirement annuity.

Retirement annuities have a place and they are not necessarily first as an investment.

Yes, we are in a technical recession meaning that our net growth on products and services has contracted for two consecutive quarters (-2,6% and -0,7%).

Increased taxes was not the solution

Personally, I see the big problem being the increase in VAT and the cost of fuel which has drastically affected the battered average household. Remember how the budget was delivered by our outgoing Minister of Finance who left shortly afterwards leaving us hung dry with increases in VAT, the fuel levy and so-called ‘sin taxes’. Little wonder we now are struggling as an economy.

So what about your personal recession?

If you evaluate your personal finances how is your growth doing? A worthwhile measurement is your balance sheet measuring the market value of your assets (everything your own) over your liabilities (everything you owe). The difference, which is your net worth, should be growing at a higher rate than the prevailing rate of inflation which is currently 5,2%. 

Measuring this quarter on the quarter will give you a clear indication of whether you are heading for a personal recession or keeping abreast of the headwinds of the rise in the cost of living. 

Prevention is far better than cure

In the knowledge that your financial position is contracting, you should make drastic changes before you reach the inevitable. After all, it is easier to change your sails before a storm than in one. You will find opportunities by reducing expenditure relative to your income. The same applies to our economy. To improve our GDP and get out of a recession we have to produce more and spend less. 

All we can do is work with the things we can control. So have a hard and honest look at where your money is going. It should be allocating more to growth assets than debt. Hard times are ahead so the sooner you get a grip on things the better. Again, increasing taxes was not the route to improving our economy. It has proved to be damaging. Now we have to live with it and make a plan.

The explosive world of social media is driven by the need for social acceptance. The media allow a single individual to engage with a massive audience empowering them to be heard on a scale unimagined just a few years ago.

The need for social acceptance is amplified through the many social media platforms highlighting a basic need in all of us. 

We like to show off …..  

This, I believe, follows through your personal finance. A huge problem we face is that many of us need to be seen as successful and we demonstrate this through the things we buy. Cars, houses, clothing, holidays we take, etc… these purchases define us in our social circles and we place significant importance on them which impacts severely our financial independence in the future.

Wealth comes from compounding over time…                                                        

You see if you spend first and don’t pay attention to saving first then you take yourself out of the magic of compounding over time. This is the pathway to creating wealth which will liberate you from the payroll as you reach a stage whereby your future investments can provide your income.

Let’s start from the very beginning…

If there is one huge lesson in life that parents can teach their children it is to delay gratification. The ability to wait a little longer for things you want.

Not so long ago a bank made the point in an advertising campaign where they filmed some children with a sweet in front of them challenging them to leave it for a while to get a bonus sweet if they lasted. It was evident that each child went through a lot of pain to delay their gratification to get their reward. 

Today, as adults, are we any different? We find all sorts of reasons to purchase things in search of social acceptance. The evidence is found in the debt ratios of households which expounds into the debt ratios of countries. Did you know that the debt-to-GDP ratio of the US (the largest economy) is 100%? America owes what it produces…

It’s about priorities……

There’s no problem in buying nice things if you have your priorities in place. If you have paid yourself first in the form of savings for the future, are on top of your debt obligations in that you can comfortably afford them and have easy access to cash for emergencies then go ahead and spoil yourself.

However, if you overextend yourself to be seen to be successful then you incur the cost of social acceptance which robs you of financial independence in the future. 

From my previous blog creating awareness of exclusions clauses in your policies, the reality is:

It is about the business                                                                                                         The provider of your insurance has a business plan to keep it viable. The bottom line is that the premiums  (contributions received from all members of the scheme) need to be more than the claims paid out.

The provider of your insurance has a business plan to keep it viable. Premiums  (contributions received from all members of the scheme) need to be more than claims paid out.

So they will be very aware of the risk you present to them in terms of claiming as well as environmental risks which affect the pool of members. This is where certain standard exclusions are imposed. These create a blanket effect on their entire model and this reduces their risk significantly. Acts of god – earthquakes and floods for example.

Medical aids are at risk                                                                                                  With medical aids the regulations do not allow them to refuse you as a member, so you can join any scheme you want to at any age. However, regulations are also in place to allow the medical scheme to apply conditions to protect them from people joining only when they need to. For example, one could stay off medical aid until one need an operation. Join the scheme, have the op and then leave after the recovery. A huge bill would then be paid by the scheme with a very small contribution.

Medical aids, therefore, are entitled to exclude any pre-existing conditions when you apply for a period determined by the condition and the risk related to it. They are also allowed to apply a penalty or loading to your premium if you have not been a continuous member of another scheme. This loading allows them to recover premiums in anticipation of the risks of future claims. 

Life companies focus on your health and lifestyle risk                                                     Life assurance companies which offer life cover without medicals will also apply exclusions for certain pre-existing conditions. If you already have a life-threatening disease you bet the assurer has an exclusion clause in place safeguarding it from your pending claim. 

Be savvier with your policy

So understanding how insurance works will help you make more reasonable choices.

• You get what you pay for – cheap is not necessarily better
• Check to see what benefits are actually provided for
• Declare everything at application – rather overstate than leave things out
• Don’t hide anything – keep honest and transparent

It is better to be rejected on application and save all those premiums than start a policy and be rejected when you have a claim.

Your life assurance policy protects you in the event of death, disability and dreaded diseases. It is a cost-effective way of making provisions if you do not have the capital to provide for any of these life-changing events. However, T&Cs apply…

Why are exclusion clauses applied?

Exclusion clauses are normally legitimately included in life assurance policies to stop policyholders from making fraudulent claims, such as deliberately shooting themselves in the foot so they can receive a disability benefit. So they protect the financial well-being of the company as it relies on claims paid out to be covered by premiums collected.

Underwriting evaluates risk

Life Assurance Companies consider your lifestyle habits when underwriting your application. They essentially evaluate the risk that they are taking relative to the benefits being applied for. For example, a news correspondent in a war zone poses a much more serious risk to the assurer than a receptionist in a beauty salon..

The assurer will also consider habits such as smoking and drinking in conjunction with your medical history. 

Changes in your life may obligate you

Now, what you need to be aware of is the fine print in some policies which may obligate you to inform the assurer of any changes to your job or lifestyle habits. For example, if you take up sky diving or any other hazardous pursuits you should check with your assurer that you are covered. 

Pre-existing conditions 

Be very aware of policies which do not require any medicals. They probably exclude any pre-existing medical conditions. If you are not aware of this you may think you have cover which is not actually there.

The suicide clause

A common exclusion clause in the assurance industry is for suicide which most companies apply for a period of two years. However, be aware of the definitions in your policy as some exclusions clauses use wider terminology such as ‘self-inflicted injury’ which could have far more reaching interpretations to a claim.

Intentionally breaking the law

Another example is, say, you go out and drink too much, drive home too fast on worn tyres and are seriously injured in an accident. Your life assurance company may repudiate a disability claim on the contravention of an exclusion clause stating you may not intentionally break the law. Drinking and driving is a criminal offence and so is breaking the speed limit as well as driving a vehicle which is not road worthy.

Changing policies needs careful attention 

So be aware of the exclusion clauses imposed upon you in your policy. This also speaks to the importance of comparing the differences in definitions when changing policies. Older policies may have fewer restricting clauses than newer ones. The law leans in favour of the assurer at the end of the day so you need to understand the conditions of your cover as much as you can,

When you move from one job to the next or if you are retrenched or decide to resign there are some important things to attend to before leaving your company which will guard your financial security.

Preserve your retirement fund                                                                                  

 You have options to transfer your retirement fund benefits to a retirement annuity, your next company’s retirement fund or your own preservation fund. By doing so you will avoid paying the tax if you cash in your fund. 

A preferred option is the preservation fund as you can access the fund once, in part or fully,  before retirement age 55 at which time you pay the tax. The great advantage is you get to compound on the full value (the tax saved) which grows the fund that much more. The preservation fund becomes a superb safety net for your future if things don’t work out in your next job and you need time to find another one.

Review your insurance                                                                                             Check with the scheme administrators if you have a continuation option on your benefits. This will allow you to take out a new policy with these benefits without having to qualify for medicals. If you have health issues you are probably not insurable. This option keeps you insured as you retain the same benefits automatically. This option should be made in conjunction with your new employer’s benefits and your personal assurance portfolio.

Ensure continuity with your medical aid                                                                     Be very careful to ensure that your medical aid plan continues when you leave. Arrange with your employer to advise your scheme that you are leaving and ensure that you set up payment details from the day you leave your company. 

Medical aid covers you like any other insurance provided your premiums are paid. Your continuity on the fund will also avert any potential penalties for joining a new fund in the future.

Changing your job is a life-changing event which has financial implications. Make sure that you attend to these important areas to ensure that you continue your financial protection from the day you leave your company and don’t risk even a day in between.

The increase in VAT to 15% announced in the Budget Proposals will affect you in more ways than you think.

Recent rumours that existing contracts such as cell phones and motor vehicle loans will not be affected are nothing more than wishful thinking. Perhaps even a ploy for April Fools….

The fact of the matter is that VAT cannot be avoided or controlled by a contract. VAT is an inclusive rate of tax and cannot be limited, capped or avoided by any contract. If that was the case, Treasury would have a very difficult time controlling revenue collections.

VAT is charged all over the place

Your lights and water account has VAT charged on all services including rates and taxes. Your DSTV, internet and armed response companies are also affected. In fact every service and product that you purchase will be affected.

Investments yields are affected

Your returns on your investments are affected by the increase in VAT. Admin fees, advisor and fund manager fees are all subject to VAT. These fees are deducted from your returns and the net amount is yours. So your rate of return on investments including pension funds will be reduced.

So the hike in VAT is unavoidable and cannot be averted. We all will be affected in more ways than we realise and no existing contracts can avert the increase.

The consumer price index in South Africa increased 4 percent year-on-year in February of 2018, easing from a 4.4 percent rise in January and below market expectations of a 4.2 percent gain. It was the lowest inflation rate since March 2015.

So what is inflation all about?

Economies depend on the value of their currencies to improve the standard of living of their populations. The cost of living is carefully measured by monitoring the prices in a basket of goods. These prices are factored into an overall percentage which is known as the consumer price index or CPI.

The rate, theoretically, represents the purchasing power of a country’s currency year on year. It stands to reason that the higher this rate climbs the less the purchasing power will be in the future.

Your investments should grow above CPI

If you want you to improve your financial well being your wealth needs to beat inflation. R100 a year ago will have a current purchasing power of R96 at the current CPI of 4%. So the R100 will need at least a 4% return to keep the value over a year and to improve its value and the return should be above this rate (known as the real rate).

We have differing inflation rates

The CPI is an index of 400 items. It can be argued that we all have our own inflation rates depending on the items we actually purchase in the basket. White goods such as televisions and fridges tend to become cheaper over time and these bigger ticket items bring the average down. We don’t buy these items as frequently as food and petrol. So many South Africans may well experience a much lesser value of their rand than the quoted 4%.

Keep a close eye on inflation

When you negotiate your next increase (if you are lucky to get one) be aware of the prevailing rate of inflation. Companies manage their businesses around the rate to ensure that their valuations are real. Your personal wealth needs to do the same. If you are improving above inflation you are growing and if you you are falling behind.

What is trust?  

It is an entity created by someone who relinquishes ownership of assets and passes the control to elected trustees.

The main advantages are:
Asset protection
As the assets no longer belong to you and are owned by the trust they are protected against creditors and legal claims against you. If you are in business, for example, and your go insolvent, creditors cannot get to the assets which are in the trust.

Protection of minor children
A trust is useful to make provisions for minor children who are underage and cannot make financial decisions for themselves. Trustees are appointed to work with a guardian to ensure that the interests of a child’s financial well-being are carefully catered for and protected.

Protection of long-term growth assets
If you plan to keep assets for the provision of generations to come, such as a farm, or a share portfolio as a legacy, then trust is useful as the assets are not disposed of at your death because they do not form part of your estate. This can save huge estate duty costs and capital gains taxes.

Trusts have highly taxed The downside of a trust is that it pays a flat rate of 45% and it does not get any rebates or exemptions on interest or capital gains tax.

The bottom line…….                                                                                                            We all get R3 500 000 off our estates before estate duty is applied. This can be passed on to a surviving spouse. So if you have a joint estate of under R7 000 000 you probably won’t benefit that much from a trust. If your tax rate is below 45% then apart from the reasons mentioned you won’t need a trust.