Johannesburg - The number of opinions on how you should save for retirement are as many and as diverse as the coaching suggestions that fans have for Shakes Mashaba and Heinecke Meyer.
Among the most frequently heard options are:
Buy property and rent it out
Pros:
An investment that is as safe as houses can surely not go wrong, and you can increase the rent every year to keep up with inflation. If you are still paying the bond, you can subtract any losses against tax and the property itself goes up in value, thereby offering an investment that grows on two fronts.
Cons:
You invest in a rental property with money after tax, which means that your money is worth less than if you were able to invest it before it was taxed. In much the same way your growth in value would be subject to capital gains tax and if your property stands empty for two months or more you will take a year at least to catch up on lost investment growth. You also run the risk of investing in only one asset class (property) and with looming interest rate increases might find yourself owning a loss making assets that you can’t sell, not even to mention the possibility of landing up with the tenant from hell that destroys your asset and runs up a huge repairs bill.
Pay off other debt with that money
Pros:
Credit card debt and other debt can be very expensive, and paying them off will technically save you the interest rate that you would have paid on the debt, which indirectly means that you have saved money at that interest rate.
Cons:
International research shows that more than 90 percent of people return to their old habits and old debt levels after paying off their debt, because their needs and habits do not change. Only now, you are trapped by your debt because you do not have a nest egg to pay it off with anymore.
Play the Lotto, get involved in a get-rich-quick scam or hope for a big break
We all have those dreams and hopes of an inheritance from a long lost rich uncle or a Powerball lucky break, but the reality is that your chances are greater to be eaten by a crocodile and struck by lightning at the same time than to get rich quickly. Unfortunately, this dream makes people do silly things, like fall for get-rich-quick schemes that offer overnight riches and then disappears with your hard earned money.
So if these plans are flawed, what is the best way to invest for retirement?
A retirement annuity (RA) offers incredible benefits that will see your funds grow ever-faster, provided that you have the patience to start investing early and keep at it until the day you exchange your business dress for your golf clubs.
Here’s how:
RAs are a catch-all phrase that refers to any investments made for the purpose of retiring. This means that while you have a certain amount invested in RAs, your funds may be divided into stocks, bonds, cash in the money market and other investments.
The benefit of an RA is that you can invest pre-tax money into these funds. This means that your money is worth so much more when you invest it, because you did not have to pay tax at your prevailing tax rate on these funds. In South Africa, you can invest up to 15 percent of your pre-tax money into a retirement annuity investment.
This benefit of course changes at the end of this tax season, so it is your last chance to invest an uncapped amount of your pre-tax savings into an RA. After that (1 March 2016), the law changes and you are allowed to set aside 27.5 precent of your pre-tax income, but this amount will be capped at R350 000 before taxes start to apply.
But your tax benefit does not end there. By investing in an RA, you do not have to pay income tax or capital gains tax on the fund growth, which becomes available to you after the age of 55.
An RA is also beneficial, because it does not become subject to estate duty tax if you pass away. A house or cash investment becomes locked into a deceased estate until it is sorted out and paid out according to the will, often while being taxed in the process. In contrast, an RA is transferred directly to the family or other beneficiary of the deceased as identified in the will, without being subject to the drawn out estate management process.
Lastly, you have the benefit of compound growth. Compound growth means that the rate of growth increases as the funds that have grown in the past increases. To best illustrate this, consider this example:
The story of two friends. Investor A started saving an amount of R1,000 a year from his 19th birthday, but only invested for a period of 9 years. His friend, Investor B, only started saving at a later age of 28, but he invested for the rest of his life to the age of 65. (38 years). At age 65 Investor A was wealthier than Investor B - how is this possible? – the power of compound interest!
Compound growth means that the person who starts first will see significantly more growth over the life cycle of his or her investment than someone who starts late. With that in mind, you should consider the investment in an RA as your first priority, before considering investments in property or other investments.
IOL
Wouter Fourie is a CFP and 2015/16 FPI Financial Planner of the Year