157 - A late starter's guide to retirement savings

Question:

My father is in his 50s with no retirement savings whatsoever. He wants to retire in 10 years time.  I know that he has left it a bit late and that he will probably not have a decent pension.

What is the best vehicle for him to use in order to make up some of the lost ground?

Answer:

When we retire, we need to budget on living of our retirement savings for the next 35 years. As your father while only be investing for 10 years in order to provide for a 35 year retirement, it will be a challenge to provide him with a viable pension. We therefore need to plan carefully in order to get the best possible returns on his investments.

When it comes to choosing a vehicle for retirement, we need to consider income tax while you are investing as well as the loss of income due to tax when you have retired.

You are allowed to invest 27.5% of your taxable into a retirement saving vehicle.  This investment amount will be deducted from your taxable income and will result in a significant tax break and allow you to invest even more into your retirement savings.

For example, if your marginal tax rate is 40%, an investment of R100,000 will cost you R60 000 once you take the tax deduction into account.  Put differently, an investment of R60 000 will give you a retirement annuity worth R100 000.  This works out do an immediate return of 66%.  This is a fantastic return before there has been any growth in the investment. This is a great way for your father to rapidly increase the size of his retirement investment.

Your father is probably in his maximum earning years and paying his highest level of tax. I would certainly recommend that he considers using the tax deductions that are provided via a retirement annuity.

The downside of investing in a retirement annuity is that 2/3 of the investment must be used to purchase an annuity. This annuity will be taxed as income when you are on pension.  You are, however, allowed to take 1/3 of the investment as a lump sum, of which the first R550 000 is tax free.

I would recommend that your father does this and reinvest the lump sum into a discretionary investment where the only tax that he would pay would be capital gains tax. The capital gains tax rate is 40% of your normal tax rate.  You will only pay tax on the gains that you have realized when drawing down your income. This can result in you paying very little tax on the income from a discretionary investment. This strategy can further help your father get a better after-tax income in retirement.

Once your father has exhausted the 27.5% contributions to his retirement fund each year, he should invest R36 000 into a tax free investment.  The advantage here is that he will not pay any CGT on this investment when he makes any drawdowns from it when he retires.

I would recommend that, for at least the next 5 years, your father invests in the most aggressive portfolios that he feels comfortable with.  I would suggest that he consults with a financial advisor who can help optimize the portfolio selection to meet his needs and comfort level.

Your father has left things a little late but if he starts now and invests wisely, using the correct investment vehicles, he can certainly improve his situation.

Kenny Meiring MBA CFP ® is an independent financial adviser who helps people put investment and risk structures in place to live wonderful lives.  You can contact him on 082 856 0348 or at Financialwellnesscoach.co.za. Please send your questions to kenny.meiring@sfpwealth.co.za