If you want to plan for your retirement, it still makes the best sense to invest in a retirement fund, such as a provident fund, a pension fund or a retirement annuity, Andrew Bradley, the managing director of Capital Alliance Management Company, says.
Other options available to you include a deferred compensation scheme, as well as endowment policies and unit trusts. But based on various realistic assumptions and in terms of current legislation, a retirement fund is still your best bet.
These assumptions are:
* A R1 000 a month investment;
* A marginal tax rate of 45 percent;
* An average tax rate of 30 percent;
* An investment portfolio with 75 percent in equities (shares in companies) and 25 percent in cash, bonds and property;
* A return from all investment allocations of 12 percent, and;
* The net rental and interest income generated will be taxed within the various portfolios at the specified rates.
These rates are:
* Retirement fund - 25 percent;
* Deferred compensation - 35 percent;
* Endowment assurance policy (investment policy) - 30 percent, and;
* Unit trusts - nil percent, but income is paid out to the owner and taxed at his personal rate of tax, which is 45 percent in this example.
For the purposes of this comparison, no attempt has been made to differentiate the investment performance of the alternatives. Bradley says that as a prudentially managed unit trust portfolio could be used in any of these alternatives, this has been the selection option.
The figures in the attached chart were obtained thus:
* The retirement fund contributions were made pre-tax at R1 000 a month. The income generated was taxed at a rate of 25 percent and on payout the full value was taxed at a rate of 30 percent - the average rate assumed on the payout of a benefit. For the purposes of this exercise, the minimum tax-free payout of R120000 was ignored;
* The deferred compensation payment of R1 000 a month was also made pre-tax, with the interest being taxed at 35 percent. The final payout was also taxed at 30 percent, ignoring the first R30000 tax-free from a deferred compensation scheme;
* The endowment policy does not allow members to make a tax deduction on their contributions. The after-tax contribution of R550 a month was therefore used. The interest income within the portfolio was taxed at a rate of 30 percent, being the tax portfolio rate for individually owned policies.
* At policy maturity, a tax-free payout was provided for. Legislation makes no provision for tax on the payout of an endowment policy, and;
* Unit trusts do not make provision for a tax deduction on contributions. Therefore, the net after-tax contribution of R550 a month was used. As unit trusts are merely a conduit, and not a tax paying entity, the interest earned within the unit trust portfolio was transferred to the individual, and taxed at the individual's rate of 45 percent. No tax was deducted on the unit trust payout.
Having based these assumptions over a period of five, 10, 20 and 30 years, indicates that the retirement fund is still the most attractive option, says Bradley. However, should you investigate the alternative of an equity unit trust with an equity component of 95 percent, and five percent in cash performing at a rate of 12 percent, Bradley says it can be noted that over a period of time (because of the lower cash component and therefore the lower tax rate applicable), the equity unit trusts start to catch up to the deferred compensation and provident fund alternatives.
Bradley says if you further assume that an equity based portfolio should outperform a balanced portfolio over a long period by at least two percent a year, the scenario starts changing significantly.
Should you choose this alternative, after about 12 years the equity unit trust will start outperforming the best alternative, being the retirement fund, Bradley says.
This is in line with Finance Minister Trevor Manuel's philosophy that we should focus more on our discretionary savings, says Bradley.
Manuel believes that South Africans sacrifice far too much of their salaries into retirement funds and therefore do not have enough disposable income, which results in excessive debt being built up and not repaid.
The minister would like to see a situation where individuals have their full income paid out, after tax, settle their debts as well as discretionary expenditure, and only then save. Therefore, the removal and/or reduction in the attractiveness of retirement funds are in line with this policy.
It is in this area that Bradley says he disagrees with Manuel - on the simple investment principle that you should pay yourself first.
This means that your investments should be made first, and only then should you look to your other expenditure.
If you approach it the other way around, you invariably have no money left to invest. This may not be problematic now, but it is one of the major contributing factors why so many South Africans retire financially dependent, Bradley says.