Email your questions to [email protected] or fax them to 021 4884119. This feature is sponsored by Old Mutual Wealth.
Should I use a tax-free savings account to save for my child’s education?
How advisable is it for me to save for my son’s education by opening a tax-free savings account (TFSA) in his name? In my view, it will use up most of his contribution limits (R30 000 a year to a maximum of R500 000), so he will be extremely restricted in how much he can save in the account once he reaches adulthood.
J Pettigrew
Rory Shea, a financial planner at Old Mutual Private Wealth Management, responds: It depends on your investment time horizon. TFSAs should be used for long-term (15 years or more) savings, to maximise the benefits of the product, and you should not dip into your savings in five or 10 years’ time to pay for your son’s education. Over the long term, the main benefit of a TFSA is that your investment is free of capital gains tax (CGT). You should, therefore, invest mainly in growth assets. There is no point in using a TFSA to invest in cash instruments until you have built up a significant amount.
To derive the maximum benefit of a TFSA, you should top it up with the maximum annual contribution of R30 000.
There are three factors to consider when using a TFSA to finance a child’s education:
• Once he or she turns 18, he or she could access the funds and you would have no control over the investment. This would also be the case if you invested directly in unit trusts in your child’s name.
• You will be using his or her lifetime TFSA allowance of R500 000. As a result, you might inadvertently be preventing him or her from using a TFSA at a later stage when he or she wants to save for a long term goal. Remember that withdrawals are not taken into account when the annual or lifetime limits are determined – you lose the value of that withdrawal from the lifetime limit.
If you invested the same amount directly in a unit trust for your child, it would still be largely tax-free and you would not affect his or her ability to use a TFSA for him- or herself later in life.
• You can invest up to R30 000 a year in a TFSA for your child, whereas there is no restriction with unit trusts.
A sensible order of priorities for saving over the long term would be:
1. Pay off short-term debt;
2. Build up an emergency fund equal to three to six months’ expenses;
3. Make full use of your tax deduction on retirement fund contributions (27.5 percent of taxable income);
4. Use up your annual interest abatement (R23 800 for people under 65 and R34 500 for people over 65);
5. Consider investing R30 000 per person in a TFSA; and
6. Use unit trust funds to invest discretionary savings for the long term.
Advice for a student who wants to save
I am 18 years old and earn money from waitressing part-time. Next year, I am going to university to do a BCom. When I am finished, I will do my articles and then I hope to travel overseas. I want to build up my savings so I can buy a car when I do my articles, or so I can pay for the overseas trip. I am thinking of putting them in a fixed bank account, but I believe I can earn a better return in unit trusts. However, I am worried that I could lose money. What do you suggest?
Samantha Claassen
Henry van Deventer, a wealth strategist at Old Mutual Wealth, responds: One of the most difficult financial challenges is how to get started when it comes to saving. As a rule of thumb, it is usually a good idea to ensure that you have a pool of funds available for the expenses you know you will incur over the next few years. You’ve obviously thought this through carefully and have a clear idea of what these are.
When it comes to investing for short-term expenses, you should minimise the chances of losing money and ensure that the money will be available when you need it. You must also accept the fact that less short-term risk and lower returns go hand in hand.
Most unit trust funds invest in shares, property, bonds, cash and similar asset classes overseas. This means that, although they stand to do well in the long term when the ups and downs of markets even out over time, they stand a greater chance of losing money in the first five years or so of your investment.
Considering that you will need your money in the next few years, it would make sense to look at investments that do not suffer from ups and downs and that will allow you to access your money easily, while still providing the benefit of some growth. Products such as a money market fund or a fixed deposit would probably make the most sense.
A money market fund is a cheap and easy way to invest in a unit trust that invests in a selection of hand-picked fixed interest-bearing securities and earns interest, similar to a bank account. There is no risk of your investment value going down. You should also earn better interest than you would with a normal bank account, and you will be able to access your money fairly easily. Speak to your bank and look at some options online to get an idea of which money market funds and fixed deposits offer the most attractive rates. Using these savings to avoid taking out debt as a student in the next few years is likely to be one of the best financial decisions you will make.
Is it realistic to expect young adults with debt to save for retirement?
I often read that unless people start saving for retirement from the day they start working, they have no hope of retiring with nearly enough money. I don’t know how that is realistic, because most people I know who are starting out in life are finding it difficult to repay a student loan and a car loan and pay rent, not to mention keep up with all the price increases – for example, electricity and food. I don’t think it’s worthwhile to save what will, in any case, be a very small amount for retirement when a person has debt commitments. Surely it’s better to pay off the debt and save for retirement later in life when you have “serious” money to invest.
M Sithole
Henry van Deventer, a wealth strategist at Old Mutual Wealth, responds: The issue of paying off debt and saving for the long term is one of our most important financial planning decisions. When we look at a framework to help guide us in making this decision, there are two things to think about: the numbers and our behaviour.
The numbers behind this decision are fairly straightforward. If I’m paying more interest on my debt than the growth I could earn if I invested it, it makes more sense to pay off the debt.
A typical moderate balanced portfolio will, over time, conservatively deliver a return of about four percent above inflation (about 10 percent a year). Using tax-efficient vehicles such as retirement funds (pension funds and retirement annuities) should add an extra one percentage point (taking the return to about 11 percent). So, if you’re paying interest on debt at less than this (usually on “big debts”, such as a home or car), you should, over time, be better off investing the money. If, however, you have “expensive” debts with higher interest rates, such as clothing accounts, personal loans or credit cards, it makes more sense to pay off these debts first – and to close these accounts or reduce your credit limits once this has been done.
The challenge of our behaviour is a little bit tougher. By first paying off debt, it’s easy to get caught in a cycle of escalating debt. You might, for example, pay off your medium-sized car and then replace it with a bigger car. It’s human nature to fall victim to such temptations, and by doing so, we make it impossible to start saving, because our short-term lifestyle decisions destroy our capacity to save for the long term.
By making saving a habit from an early age, we achieve two things. First, we channel the money that would otherwise have gone towards our short-term lifestyle expenses towards a long-term savings pool. Second, we harness the power of compound growth.
Compound growth is when we receive growth on our growth. An investment growing at 12 percent a year will double in value roughly every six years. This is why people who start saving early need to save much less than those who start late: they have the benefit of time to earn extra growth on the growth on the investments.
If, for example, you saved R1 000 a month for 40 years at an annual return of 12 percent, you would have more money than if you saved R10 000 a year with the same growth for 20 years. So, if you want to save less and earn more, your greatest ally is time.
• Old Mutual Wealth provides integrated wealth planning and goal-based planning through financial planners, backed by global expertise and research. In order to create Old Mutual Wealth, Old Mutual has consolidated the expertise and resources of several established businesses: Acsis, Fairbairn Capital, SYmmETRY Multi-Manager, Old Mutual Unit Trusts, Old Mutual International, Celestis, as well as some investment consulting resources from Old Mutual Actuaries and Consultants. Strengthening Old Mutual Wealth’s position is the recent acquisition of Fairheads Trust Company.