RETIREMENT INVESTMENTS

I have worked for the government for 32 years and wish to resign. I would like to have the full cash-out option and pay off some debts, buy a property for rental income and buy a living annuity with the balance. I am 50. Are these sensible decisions with my R3.014 million? I will qualify for the pre-1998 tax-free contributions.

Name withheld

Graham Lovely, a financial adviser at PSG Wealth in Rondebosch, responds: Since you are not yet 55, you cannot retire from the government pension fund (and depending on the fund rules, the earliest retirement date may only be 60). You have the option to have the amount transferred to you as a cash lump sum, which will be taxed according to the South African Revenue Service’s withdrawal tax table. The second option would be to transfer your benefit to an approved retirement fund – for example, a retirement annuity or preservation fund. This transfer will be tax free.

You have indicated that you wish to take the full amount as cash. Considering your years of service, you will be entitled to vest pre-1998 benefits, which will not be taxed. At resignation, only the first R25 000 of the taxable lump sum (which we calculate to be about R1.9 million) will be taxed at 0%. Bear in mind that if you leave your funds untouched until retirement age, your tax-free portion would be substantially larger, at R500 000.

Should you elect to take the full amount in cash, you will receive the payout net of tax. This is then discretionary capital with which you can do as you wish, including paying off debts and investing for a passive income stream. Should you wish to purchase an annuity with this capital, it is important to take into consideration any tax payable on the income you receive from it.

You could rather invest this capital in a voluntary unit trust investment with advice from a qualified adviser on how to allocate the funds and what your maximum withdrawal rate should be.

If you transfer to a preservation fund, the transfer is tax-free. The once-off withdrawal you are allowed prior to retirement is usually limited to a third of the fund value when the source of funds is from a government pension fund. (It is not like other pension benefits, where the entire amount in the preservation fund can be withdrawn as a lump sum.)  Any withdrawal may be taxable and it is important to take into consideration any vested pre-1998 benefits, as this will still be applicable to any lump sum taken from the preservation fund.

Any remaining amount in the preservation fund will be accessible only at retirement. You are usually eligible to retire at 55, but some fund rules stipulate only from 60 onwards.

At retirement, the funds will need to be used to purchase an investment linked living annuity and you will select an income of between 2.5 and 17.5% per annum which is not guaranteed for life and depends on the drawdown rate.

Because you are only 50, you will probably have to wait until you reach retirement age to purchase an annuity. You are not forced to retire at 55 and can choose to retire at a later stage.

It is important that you first check the rules of your government pension fund on the implications of choosing to resign. It is equally important to consult a financial adviser before you resign to better understand your options and their implications.


WHERE TO INVEST?

I would like to invest R2 000 a month and although my plan is to save it for the long term, I might want or need to access it at some point. From what I have read and heard, it seems like a monthly debit order to a unit trust investment would be sensible, but are there any pitfalls I should be aware of when it comes to unit trusts?

Name withheld

Magdeleen Cornelissen, a financial adviser at PSG Wealth in Menlyn, Pretoria responds: South African investors enjoy access to a vast number of unit trust funds, which are easily accessible via various investment platforms. The key is to select the right fund for your needs.

In order to establish which unit trust fund would address your needs best, you need to consider your investment strategy, focusing on the term of the investment, your appetite for risk, as well as your possible future withdrawal requirements. Spend some time thinking about your own investor behavior, specifically focusing on your tolerance for volatility, and your need for a certain outcome. Once you have done this, you will be one step closer to knowing which type of fund would best suit your needs.

Remember that each investment vehicle is associated with a unique set of rules and that there are negative and positive points associated with each investment option. Before investing, it is important to understand the rules of the product, which in your case is a unit trust portfolio. What stands out about a unit trust investment is the fact that the product is open ended and that clients have access to their capital. In contrast to retirement investment products, there are no asset allocation restrictions.

Taking into account your need for liquidity, it is worth mentioning that a unit trust investment would most likely suit your needs best, However, finding the correct fund is where your challenge lies.

As far as pitfalls go, the big focus will be on the funds that you select for inclusion in your portfolio. Be careful not to focus only on the “winners” of the past, as historical performance is not always a reflection of future outcomes.

I am also always tempted to have a conversation with risk-averse clients about the fact that shying away from assets that are perceived to be risky can actually increase the risk of not reaching their long-term goals. This is especially true after taking into account the effect of taxation and inflation.

For investors who have a high risk appetite, on the other hand, my strong recommendation is to be mindful of the investment term. You haven’t stated when you think you may need to access the funds, but if you suspect this would happen within the first five years of investing, steer clear of assets associated with volatility.

If you have a high risk appetite, you’ll need to be able to give your investment portfolio sufficient time to digest the fluctuations that can occur from time to time. Having a high appetite for risk is sometimes your biggest asset, but it can quickly turn into a liability if not managed correctly.


DO I NEED MEDICAL INSURANCE?

I have recently seen a close friend’s financial situation spiral out of control due to unexpected medical costs for his wife who is fighting cancer. Although they both have what he thought was comprehensive medical scheme cover, not everything is covered, and the costs are adding up dramatically. It got me thinking about my own situation, and whether I need any insurance over and above my medical scheme. Do you have any advice or recommendations?

Name withheld

Ronald King, head of public policy and regulatory affairs at PSG Konsult, responds: There is no way anyone can face the future without a medical scheme, but developments in medicine are taking place at a pace medical schemes can’t keep up with.

A medical scheme will only cover a medication once it has clear statistics collected over several years. So, when it comes to diseases involving extensive research, it may happen that the medical scheme won't cover the cost of the latest treatments.

According to Momentum, the difference in costs charged for cancer treatment and costs covered by a medical scheme may easily amount to R1 million. This is enough to ruin most financial plans. Gap cover may compensate for some of the shortfalls but will also fall short when it comes to these treatments.

This is where dread disease cover plays an important role. This cover pays a predetermined amount on diagnosis of a dread disease. As with any insurance, not all types of dread disease cover are the same.

Standalone versus accelerator options. With standalone dread disease cover, your life cover is not reduced after a claim for a heart attack.  Accelerator options are cheaper, but they do reduce your life cover, so standalone cover is preferable.

Limited versus comprehensive cover. Some insurers cover only 20 major diseases, while others include more than 400 conditions. As a matter of interest, insurance for the 20 major diseases covers 94% of all claims, which means you might pay twice as much just to obtain cover for the additional 6%. If you have a family history of a condition not in the 20 major diseases, more comprehensive cover is a better option. If not, rather make sure the amount of cover is sufficient.

Reinstatement options. Some types of dread disease cover offer a reinstatement option. This means cover will be paid out again if you suffer a second dread disease that is not a result of the first disease. This benefit may become invaluable.

Payout stage. All dread diseases have levels of severity. The more severe the illness should be for the cover to pay out, the cheaper the cover will be. Make sure that cover is not paid out only when the disease is so severe that nothing further can be done.

Email your queries to [email protected] or fax them to 021 488 4119. This feature is sponsored by PSG Wealth.