Life-stage financial planning is essential to ensuring that your investment goals are met as you transition through your different life stages. Those with a sound financial plan usually achieve their life goals because they have a clear path and robust strategy of wealth creation to meet those objectives.
Although goals and requirements change over time, planning ahead and early enough, gives you an opportunity to review your financial plan annually and make the necessary adjustments.
Let’s look at some of the important investment decisions that you will make at various stages of your life.
20s – 30s
As you start your career, there is a balancing act between needs and wants, and a temptation to spend on items that will not benefit you in your later years. Being financially disciplined in your early years of saving yields significant advantages later in life, as you benefit from compounded returns. Albert Einstein said that “Compounding is the 8th wonder of the World. Those who understand it will earn it, and those who don’t will pay for it”. This is true when it comes to saving for any long-term goal. Compounded growth means that every year you earn returns on your capital plus on your returns that you already received. Compounding can create a snowball effect, as the original investments plus the income earned from those investments grow together. The more time you spend in the market, the more growth potential you are exposed to. Try and start saving as early as possible; time is an investor’s friend, and age is on your side.
If you are not participating in an occupational retirement fund (employer pension or provident fund), it would be wise to start saving for retirement with a retirement annuity. One of the significant advantages of investing in a retirement fund is the tax benefits afforded by government. Retirement fund members are allowed tax-deductible contributions to their retirement fund of up to 27.5% of the higher of their taxable income or remuneration, capped at R350 000 per tax year. These deductible contributions reduce an individual’s taxable income during the year of assessment and thereby reduce their overall tax liability. With inflation at 7% and medical inflation between 8 – 10%, it makes it harder to contribute more to a retirement fund as expenses increase, however, it is important to stay the course and make retirement fund saving a priority.
Your next important decision would be to consider investing a maximum of R36 000 per tax year in a Tax-Free Savings Account, where all growth within the fund will be tax-free. Lastly, any disposable income could be invested in a discretionary investment like a unit trust, with a higher allocation to risk assets like equities. Equities are the asset class that has the highest probability of providing inflation-beating returns over an extended period of market cycles.
30s – 50s
This is the wealth accumulation stage of your life where you are not only growing in your career or business, but you are most likely growing your family too. Budgeting becomes increasingly important as any additional income should be used to settle any debt that you may have and reduce your bond.
A prudent approach would be to start an emergency fund. A great vehicle for this is a unit trust investment as it allows for quick accessibility when an emergency does arise. A good rule of thumb is to target having at least 3 months of expenses saved in an emergency fund to cover any unforeseen expenses.
During this stage of your life, changing jobs within your career is a possibility. A preservation fund allows you to preserve your pension fund or provident fund savings when you change jobs. One of the main reasons for not maintaining your standard of living after retirement is due to cashing in on your retirement fund when changing jobs, so preserve as much as you can.
Geographic diversification is essential when managing your overall portfolio. Investing offshore in a global fund can be an ideal way to gain offshore exposure which allows you to access a wider set of opportunities and markets that may be experiencing higher growth. Direct offshore investments are subject to Exchange Control Regulations. The South African Reserve Bank (SARB) allows South African resident individuals a R1 million Single Discretionary Allowance (SDA) per calendar year, with no foreign tax clearance required from SARS. SARB also allows a further R10 million Foreign Capital Allowance (FCA) per calendar year, subject to a foreign tax clearance from SARS which is valid for 12 months.
Lastly, endowments are a great way to save for high-net-worth individuals whose marginal income tax rate is higher than 30% as endowments are taxed at a fixed rate of 30% within the fund. It is a dedicated vehicle that can be used to save for any medium-term goals like saving for your child’s education.
50s – 60s
As you approach retirement it would be wise to review your financial plan and prepare for post-retirement.
Your existing portfolio should be diversified and have a balanced approach as you near retirement age to ensure that you are not exposed to undue market risks. This is done by limiting the exposure to more risky asset classes. The idea behind diversification is to look for asset classes that have low correlations so that if one moves down, the other tends to counteract it.
One also needs to assess retirement funding. How much is enough? That’s always a difficult question to answer as it is very much lifestyle dependent and will vary from person to person, however, as a general rule of thumb, Financial Advisors would tell you to try and target a 75% replacement ratio for post-retirement. What that means is that for every R1,000 earned before retirement, you are targeting to replace R750 as an income during your retirement. So how do you achieve this? On average, members that contribute around 15 – 17% of their salary over 40 years (from age 25 to 65) towards their retirement savings tend to get close to achieving a 75% replacement ratio. Consult a Financial Advisor who can assess your current contributions and identify if there is a retirement gap that needs to be closed with additional investments.
Retirement years
At retirement, two thirds of your retirement fund savings must be used to purchase an income annuity. Pensioners face a decision between choosing a guaranteed life annuity or an investment-linked living annuity. Both are post-retirement income products which offer different propositions. Firstly, what are they? Guaranteed life annuities will pay you a fixed income with annual increases for the retiree’s life, irrespective of how long they live (typically issued by a life insurer). That’s the biggest advantage of a life annuity in that your income, with inflationary increases is guaranteed for the rest of your life. The downside, however, is that it is not a legacy product in that it is not designed to pay an inheritance to your beneficiaries, so once you and your spouse pass on, the remaining savings will accrue to the insurer.
Living annuities on the other hand are investment linked, it gives much more flexibility, in terms of the amount you withdraw every year. An annuitant can draw down between 2.5% and 17.5% of capital as an income. The advantage of the living annuity, apart from the flexibility of choosing your income level, is that it is a legacy product in that your nominated beneficiaries will receive your retirement savings when you pass away.
The downside of a living annuity, of course, is that because it is investment-linked, you take on the market risk, and in a low-growth, high-inflation environment such as the one we find ourselves in, there is a risk that if you take a drawdown level that is higher than the return within the fund you invested in, then you start eating into your capital and run the risk of outliving your capital. Therefore, the longevity risk is a material risk for many pensioners.
So how do you choose between the two? The choice comes down to the retiree’s preference for either income security or leaving a legacy. Speaking to a Financial Advisor can help you make that decision.
The table indicates the fund suitability for each of our unit trust funds. These funds can be selected in various product types, so if you are looking at discretionary savings, saving for retirement, using a Tax-Free Savings Account or even an endowment – we have a fund that caters for every need that you may have.
