Retirement Planning
To have a comfortable, secure, and fun retirement, you need to build the financial plan that will fund it all. Planning for retirement starts with thinking about your retirement goals and how long you have before you must meet them. Then you need to look at the types of retirement accounts that can help you raise the money to fund your future. As you save that money, you must invest it to enable it to grow.
Understand your limits
Your current age and expected retirement age create the initial groundwork for an effective retirement strategy. The longer the time between today and retirement, the higher the level of risk your portfolio can withstand. If you’re young and have 30-plus years until retirement, you should have most of your assets in riskier investments, such as stocks. Though there will be volatility, stocks have historically outperformed other securities, such as bonds, over long time periods.
You might not think saving a few bucks here and there in your 20s means much, but the power of compounding will make it worth much more by the time you need it.
In general, the older you are, the more your portfolio should be focused on income and the preservation of capital. You need returns that outpace inflation so you can maintain your purchasing power during retirement. Inflation may start out small, but given enough time, can turn into a mighty oak tree. Inflation erodes the value of your money. A seemingly small inflation rate of 3% will erode the value of your savings by 50% over approximately 24 years.
Understand retirement spending needs
Having realistic expectations about post-retirement spending habits will help you define the required size of a retirement portfolio. Most people believe that after retirement, their annual spending will amount to only 70% to 80% of what they spent previously. Such an assumption is often proved to be unrealistic, especially if the mortgage has not been paid off or if unforeseen medical expenses occur. Retirees also sometimes spend their first years splurging on travel or other bucket-list goals.
“In order for retirees to have enough savings for retirement, I believe that the ratio should be closer to 100%,” “The cost of living is increasing every year — especially health care expenses. People are living longer and want to thrive in retirement. Retirees need more income for a longer time, so they will need to save and invest accordingly.”
By definition, retirees are no longer at work for eight or more hours a day, they have more time to travel, go sightseeing, shop, and engage in other expensive activities. Accurate retirement spending goals help in the planning process as more spending in the future requires additional savings today. “One of the factors — if not the largest — in the longevity of your retirement portfolio is your withdrawal rate. Having an accurate estimate of what your expenses will be in retirement is so important because it will affect how much you withdraw each year and how you invest your account. If you understate your expenses, you easily outlive your money (there are more years at the end of your money). If you overstate your expenses, you can risk not living the type of lifestyle you want now. It is important to strike the balance.
Understanding Tax
Depending on the type of retirement account you hold, investment returns are typically taxed. Therefore, the actual rate of return must be calculated on an after-tax basis. However, determining your tax status when you begin to withdraw funds is a crucial component of the retirement-planning process. This also includes what amount one takes as a lump sum.
How the Retirement Act affects you: Before retirement
The tax deduction increases from 15% to 27.5% of income, up to a maximum of R350 000 annually, on contributions made towards structured retirement savings. It now applies across the board - provident funds, pension funds and retirement annuities. The distinction between retirement funding and non-retirement funding income has also been removed. That means all clients who were members of a pension or provident fund, and therefore unable to take out a retirement annuity, can now top-up to the limit of 27.5%. Also, only employees are able to claim contributions, regardless of whether they actually made them (companies will often contribute to a pension).
How the Retirement act affects you: After retirement
The laws mean that the rules that governed provident funds changed to the same as those that governed pension funds. Provident fund members can only withdraw one-third of their savings at retirement, and they are required to purchase an annuity with the remaining two-thirds. Effectively, one could argue that the government is looking to help protect retirees by enforcing compulsory preservation and making it impossible for hard-earned savings to be withdrawn in a lump sum.
Any lump sum withdrawn at retirement above a minimum threshold (currently R25 000) is taxable. Between R25 000 and R660 000, the tax rate is 18%, between R660 000 and R990 000 it is 27%, and over R990 000, it is 36%.
Risk tolerance versus investment objective
How much risk are you willing to take to meet your objectives? Should some income be set aside in risk-free funds for required expenditures?
You need to make sure that you are comfortable with the risks being taken in your portfolio and know what is necessary and what is a luxury. This is something that should be seriously talked about not only with your financial advisor but also with your family members.
“Don’t let the daily market noise confuse you, daily market changes are a concern for short term investors and day-traders. Although keeping track of market movements is necessary for a good investor, they’re not always a wise guide for long term investing.
When the various mutual funds in your portfolio have a bad year, add more money to them. The mutual fund you are unhappy with this year maybe next year’s best performer — so don’t bail out on it.” Markets will go through long cycles of up and down and, if you are investing money you won’t need to touch for 40 years, you can afford to see your portfolio value rise and fall with those cycles.
Estate Planning
Estate planning is another key step in a well-rounded retirement plan, and each aspect requires the expertise of different professionals, such as lawyers and accountants, in that specific field. Life insurance is also an important part of an estate plan and the retirement planning process. Having both a proper estate plan and life insurance coverage ensures that your assets are distributed in a manner of your choosing and that your loved ones will not experience financial hardship following your death. A carefully outlined plan also aids in avoiding an expensive and often lengthy probate process.
Tax planning is another crucial part of the estate-planning process. If a person wishes to leave assets to family members or a charity, the tax implications of either gifting the benefits or passing them through the estate process must be compared. A common retirement-plan investment approach is based on producing returns that meet yearly inflation-adjusted living expenses while preserving the value of the portfolio. The portfolio is then transferred to the beneficiaries of the deceased. You should consult a tax advisor to determine the correct plan for you.
Estate planning will vary over an investor’s lifetime. Early on, matters such as Power of Attorney and Wills should be addressed. Once you start a family, a Trust may be something that becomes an important component of your financial plan. Later on, in life, how you would like your money disbursed will be of the utmost importance in terms of cost and taxes. Working with a fee-only estate planning attorney can assist in preparing and maintaining this aspect of your overall financial plan.
