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How far does your financial planning go? You may be doing the right things: saving for retirement through your employer, or independently, and paying for basic medical scheme membership. These are the two most accessible financial protections and the ones we understand best and adopt earliest – hopefully, as soon as we start earning an income and well before we own property or assume responsibility for dependants. Having sacrificed a portion of our precious income to cater for almost inconceivable future needs, we feel good about our foresight and discipline.

But as we get older, take on financial commitments such as home loans and car loans, set up home with a spouse or partner, and/or have children, the starter pack above becomes hopelessly inadequate. But with limited resources and so many products and providers vying for your attention, what is the bottom line? Which financial products constitute the next tier of a long-term financial plan, providing the foundation for a secure financial future by covering risk, preparing you for a comfortable retirement and establishing a pattern of saving for immediate needs and future goals?     

To get back to basics, Personal Finance asked three well-established financial planners to abandon their preferred approach of tailoring their advice to individual circumstances and to generalise, just this once, about the minimum requirements of any and every financial plan – keeping the package to five products. If you are wondering how much you have to do to take the next step up in the hierarchy of financial planning products, this is your guide.

The planners

Barry O’Mahony has the Certified Financial Planner (CFP) accreditation, is the founder of Veritas Wealth Management in Cape Town, and is a former Financial Planner of the Year. He and his colleague, fellow CFP Rick Briers-Danks, personalised their product selection by visualising a hypothetical married couple in their 30s with two children of school-going age. “They both work and live in a home they own jointly with a sizeable bond,” says O’Mahony. “Their joint monthly income meets their living expenses, but they don’t have much room for saving.”  

Given the limits of the couple’s disposal income, Veritas ranks these products as the critical five to have:   

  • Medical scheme membership and gap cover;  
  • Income protection;
  • Life cover;
  • Retirement funding; and
  • An emergency fund.

Any extra money should be saved in a tax-free savings account, to supplement retirement savings, and/or invested in unit trusts: “a wonderful invention for a layman investor”. Finally, the couple would be strongly advised to have a will … and to have it drawn up by a trust company or a lawyer, rather than a bank. The reason for this, says O’Mahony, is that banks “typically nominate themselves as executor and are generally not as efficient at winding up estates”.

Sue and Craig Torr are the co-founders/directors of Crue Invest in Cape Town. Sue is an advocate and former head of fund management at one of South Africa’s largest healthcare administrators; Craig is a CFP.

The Torrs managed to restrict their core plan to five essential products:

  • Unit trust retirement annuity (RA) fund;
  • Medical scheme membership;
  • A will;
  • Income protection; and
  • An emergency fund.

We have not dealt with wills in detail in this article, but Sue Torr points out that most South Africans underestimate their importance and die intestate, which burdens the state and often causes enormous problems for dependants and other prospective heirs.

“Having a will is not the privilege of the impossibly wealthy. It is the right of every South African to plan their legacy while they are still alive, and we regard it as a vital part of one’s financial plan,” she says. “If you die intestate, your estate will be distributed in terms of the law of intestate succession and that might mean certain unintended beneficiaries inheriting. The Master of the High Court will appoint a curator to take care of your estate, and any assets left to your minor children will go to the Guardians Fund, where they will be administered by the authorities until your children are old enough to inherit. In addition, the state will appoint a guardian to take care of your children – and it may not necessarily be the person you would have chosen.

“Although anyone can draft a will, it must meet certain legal requirements to be valid, and it is strongly recommended that an estate planning expert drafts your will – regardless of the size of your estate. Simple errors, such as allowing a beneficiary in your will to sign as a witness, can result in him or her being disqualified from inheriting,” says Torr.  

CFP professional Melony Jacoby has been in financial services for 28 years, and is the founder and owner of MVest Finance in Durban. She splits financial planning into three categories: risk management planning, retirement planning and investment planning. Her five must-have products fall into the first two categories, with a linked investment product recommended for anyone able to put aside at least R50 a month to start an investment portfolio.

Risk-management: income protection, life cover and dread disease cover; and

Tax-friendly retirement planning: an RA and a tax-free savings account.

For the purposes of this exercise, Jacoby assumes that medical scheme membership and a will are already in place.  

If you can invest even a small amount a month, she says a linked-investment services provider, or Lisp, is the way to go, because the investor gains access to unit trust portfolios with other companies. “The benefit of a product like this is the liquidity it provides, and there are no penalties for repurchasing, reducing or even stopping contributions,” says Jacoby.

“You can also invest on behalf of other people. For example, parents can save for their children, as the minimum contribution to a particular unit trust is R50,” she says.

The essential five  

1. Medical scheme membership with gap/dread disease cover

“In our view, you simply have to belong to a private medical scheme,” says O’Mahony, who puts healthcare cover at the top of the Veritas list of core financial needs. For the Torrs, medical cover is second only to investing for retirement. Jacoby takes medical scheme membership as a given, but adds dread disease insurance as one of her three risk-management priorities.

Such unequivocal views say a lot about the potential cost of health care and the devastating effect an accident or illness can have on even the most carefully laid financial plans. “Medical aid is expensive, but the financial consequences of being without it can be crippling, and you have no control over life’s catastrophic events,” says O’Mahony.

“You can limit coverage to a hospital plan, with or without the savings element, and add gap cover insurance, which is very affordable and covers the difference between what medical aid pays and what you are charged (the ‘payment gap’).

“If you do not have private medical aid and need care, you could be turned away at the door of a private hospital, which would leave you dependent on state facilities. In some cases, state facilities are adequate, and some people are comfortable with this outcome, but most are not,” says O’Mahony.

The very minimum recommendation of the Torrs would be a “comprehensive hospital plan that covers you and your dependants at 100 percent of the medical scheme tariff. This will ensure that your medical costs are completely covered in line with medical scheme rates from the date of admission to hospital to the date of discharge,” says Sue Torr.

“However, even with a 100-percent hospital plan in place, you would be liable for all out-of-hospital medical costs, such as scans, scopes and procedures that do not require hospital admission. You would also be responsible for the payment gap, so we would always strongly recommend taking out gap cover insurance.”   

Medical scheme membership? Medical insurance? It is important not to confuse them, says Torr. “A medical scheme is regulated by the Medical Schemes Act and is designed to pay out claims in accordance with medical scheme tariffs. Medical schemes are required to provide all members with a set of ‘prescribed minimum benefits’. Medical insurance, on the other hand, is an insurance policy that pays out a predetermined lump sum for a hospital event and is governed by the Financial Services Act,” she says.

Past medical history is no indicator of your future healthcare needs, she points out. “Many people make the mistake of choosing next year’s medical scheme option based on last year’s expenditure. Your healthcare status can change overnight, and it is always advisable to have the most comprehensive medical aid plan you can afford.”

Jacoby recommends dread disease insurance because it covers shortfalls and treatments not covered by medical schemes and may also provide you with the means to access treatment elsewhere in the world. “Most important of all, it continues to cover you if you survive a dread disease,” she says.

According to the Association for Savings & Investment South Africa, 60 percent of dread disease claims in 2016 were from women diagnosed with cancer, she says. “One in three women and one in four men are diagnosed with heart attacks before the age of 60. Cardiovascular diseases are almost a common occurrence. Our toxic environment and lifestyles are reflected in the numbers of people being diagnosed and/or dying from strokes, heart attacks and cancers. In America, a million people die every year from these dreaded diseases. We don’t have accurate stats in South Africa, but, unfortunately, Western culture is having the same effect globally.”

2. Unit trust RA

There’s no better motivation for financial discipline than being on the right side of compound interest and getting a tax break thrown in. The Veritas team sums up the consensus as: “You should be using the tax break offered to you by Treasury to save efficiently for retirement. If you are not saving anything, you need to start immediately, no matter how little you can afford to save every month. Because of the compounding effect, the earlier you start the better.”

Says O’Mahony: “You are entitled to save 27.5 percent of your taxable income in a retirement fund each year (capped at R350 000) and to deduct that amount from your taxable income. Essentially, you are being allowed to invest with pre-tax income. There are other benefits of a retirement fund, too: the investment is protected from creditors and free of estate duty, and the growth in the fund is tax-free – in other words, it is not subject to capital gains tax (CGT) or income tax while in the fund.”

If your employer has a group retirement scheme, you are probably contributing to a provident or pension fund, he says. “In that case, you should consider increasing your contribution to the maximum you can afford. If you do not have access to a group scheme, you will need to set yourself up with an RA, which is essentially a private retirement fund. We suggest using a unit trust-based RA, which is flexible and allows you access to good fund managers.”

Traditionally, RAs were policies sold by life assurance companies, but they became notorious for lack of transparency, poor investment returns, high fees and penalties for termination, explains Craig Torr.

“A unit trust RA is not a policy, but a unit trust portfolio owned by the investor. It is a much more cost-effective and flexible investment structure, generally achieving more favourable investment returns than policy RAs. The investment performance of a unit trust portfolio is tracked, and all the costs involved are completely transparent. With a unit trust RA, you have full disclosure of all fees, including asset management, adviser and administration fees,” says Torr.

“As the owner of unit trusts, you have the freedom to choose which funds to invest in, subject to regulation 28 of the Pension Funds Act, which limits risk exposure in retirement funds. You can increase or decrease monthly contributions with no fear of penalties and can make ad hoc lump-sum contributions at any time. The costs of investing in a unit trust RA are significantly less than a policy RA, and the difference in cost can have a considerable impact on your savings in the long term. The ability to choose and switch underlying funds also plays an important role in the long-term performance of invested assets.”

You can transfer a policy RA to a unit trust portfolio – and you might be well advised to do so – but you need to obtain a quote from the assurer first, to find out what it will cost you to cancel your policy, says Torr. Once you know that, a financial adviser can compare the likely long-term outcome of holding on to your policy versus taking the pain of the cancellation fee to gain access to the lower costs and better performance prospects of a unit trust investment.

If you are in a position to do so, Jacoby recommends making use of all the tax exemptions available for long-term saving by investing in a tax-free savings account. “Contributions are limited to a maximum of R33 000 a year and R500 000 over a lifetime,” she says, “but all growth (interest and dividends) are tax-free and there are no CGT implications when you access the money.”

3. Income protection

If you had an ATM machine in your living room that consistently spat out your net income on the 25th of every month, would you think it was worth insuring the machine for mechanical failure?

That’s the question to ask yourself if you have no income protection, says Briers-Danks, for whom this product ranked a close second to medical scheme membership. It was the top priority for Jacoby (with medical cover assumed to be already in place) and number four on the list of five must-have products provided by Crue Invest.

“Becoming disabled is your greatest financial risk, we believe, as it could mean being without an income for many years,” says Briers-Danks. “Even without dependants, it is critical to protect your income, so you don’t become completely dependent on others. Income protection policies pay out after a waiting period – typically, seven days, a month, three months, and so on – and the longer the waiting period, the lower the premium.”  

It is important to make sure inflation is factored into your income calculation, he says, and to take into account any income protection provided by your employer as part of the company’s group risk benefits, so you don’t over-insure.

Don’t expect income protection to cover 100 percent of your income, however. That might make you better off disabled than able-bodied, explains Jacoby. “The core purpose of income protection is to support your rehabilitation, or to help you find an alternative occupation to provide an income.”

Craig Torr points out that disability is often not the result of a major catastrophic event, as we imagine; a common ailment or relatively minor accident can do just enough damage to disrupt a career – for example, loss of the sight in one eye can be devastating if you need 20:20 vision for your job.

“When taking out an income protection policy, you need to provide proof of your employment and   income and you can nominate the level of income you want to insure – for example, 75 percent,” says Torr. “In general, an income protection benefit will remain in force until you are aged between 60 and 65, depending on the age you choose.”

Income protection applications are complicated, he says. “Insurers need to have a full understanding of your current medical conditions, your employment, any occupational risks, your lifestyle and whether or not you take part in any high-risk recreational activities, such as skydiving. All these factors contribute to the underwriting of your policy, which, in turn, determine the level of insurance, and the exclusions and waiting periods that apply. Bear in mind that it is possible to take out temporary and permanent income protection through a single policy.

“Since it is quite an intricate area of insurance, it is best to take advice from a financial planner who knows these products well, to ensure you are appropriately covered when you make a claim.”

4. Life cover

Life assurance is a “life-stage” product, rather than a universal need: a core requirement for a working couple with a joint-mortgage bond and young dependants, says the Veritas team, but non-essential if you are single and debt-free. For that reason, Crue Invest did not include it in its must-have top five products.

Jacoby emphasises its versatility as an asset that is not part of your estate: for example, if you are self-employed or own shares in a company with other shareholders, she says, “life cover could be the answer to buying the shares from the deceased estate or enabling continuity while the estate is being wound up”.   

If you have a spouse and dependants, life cover can provide immediate financial support until the estate is wound up and/or ensure there is no liquidity shortfall in your estate that would require your spouse or heirs to pay cash into the estate. Jacoby warns that the proceeds of a life assurance product do not attract estate duty when paid to a spouse, but are subject to estate duty when paid to a trust or a cohabiting partner.  

She says cohabitants need to be aware that the exemptions that apply to marital regimes do not apply to cohabitation. “Life cover could be taken out to ensure that, when the partnership dissolves due to a death, all liabilities, estate expenses and ongoing maintenance for the surviving partner are provided for.”

And, of course, life cover can be used for wealth creation for your heirs, says Jacoby. “The proceeds can be paid to a testamentary trust or an existing trust, but you should be aware of the tax implications of this.”

The exact amount of life cover will depend on your personal circumstances and lifestyle, says O’Mahony, so the calculation should be made with the help of a financial planner, who can project all the important costs into the future. It is not advisable to pluck a substantial figure out of the air, because it sounds good, without taking into account the actual sum required and factoring in inflation.

5. Emergency fund

“If the drought in Cape Town has taught us anything, it is the importance of saving up … if not for a rainy day, then for a series of dry ones,” says Sue Torr, neatly summing up life’s unpredictability. “Without access to funds in the event of emergency, one might be forced into the position of taking out a personal loan, which is a notoriously expensive type of loan.

“As with disability and income protection, it is often the relatively small, unforeseeable events that result in the need to access emergency funds,” she says. “For example, a few days in a veterinary hospital for your dog can cost in the region of R15 000; or a seized vehicle engine that is out of motor plan can easily cost R50 000. The death or illness of a close family member or friend could have you scrambling for the price of flights and accommodation at a moment’s notice.”

There is no magic figure for an emergency fund, but the accepted practice is to peg it at between three and six times your monthly income, says Torr. “The most important thing is accessibility, which makes savings accounts and money market accounts good vehicles for this purpose. Even better, an access bond facility attached to your home loan is ideal for storing your fund, because the extra money will lower the interest on your loan by more than any interest you will earn in a savings or money market account.

“Bear mind in that tax-free savings accounts are not ideal for emergency funding or cash investments, because the money you save in them has already been taxed, and the real benefit of these accounts is that they are free of CGT on the long-term growth of the investment.”  

O’Mahony echoes her advice that a money market unit trust or a high-interest bank account is appropriate for short-term saving. “The quantum is up to you, but don’t make it too high because of the limitations on growth: R30 000 to R100 000 should be enough for unforeseen expenses that you need to  deal with quickly,” he says.