While many of the mooted retirement reforms will only be implemented next year, one of the first changes, effective as of March, disallows lump-sum withdrawals from provident funds, instead requiring them to be annuitised in the same way as pension funds.
Sharon Möller, Financial Planning Coach at Old Mutual Wealth, says one of the biggest current myths is that this change will somehow disadvantage provident fund members.
“The changes are actually an incentive for people to save more for their retirement and preserve their wealth. Applying a limit to the amount that can be taken as a lump sum is intended to help protect the capital.”
Möller says some of the changes set for implementation in 2016 are the introduction of fringe tax benefits on retirement fund contributions and changes to the way tax will be calculated on withdrawals.
“We believe the amendments are generally positive. Our figures show over 90% of provident fund members choose to withdraw their retirement savings as a lump sum when they retire, and this money is often used to repay debt or splurge on luxuries. The huge risk they face, is that they might not have enough to live on or, even worse, outlive their capital.”
Möller says retirement is a watershed in people’s lives and that the challenges of providing a regular income, without dipping into capital too soon, are very different from those confronted in a wealth-accumulation phase.
“It is essential to get appropriate financial advice to put the right investment strategy in place from the start. Each of the aspects relating to withdrawing and investing funds need to be considered during each of the phases.”
Provident vs pension funds
In terms of the changed legislation, only one third of provident fund contributions accumulated after March this year, will be able to be taken out as a lump sum. The remainder will need to be invested to provide a monthly pension payout. The change only applies to those who are under 55. Older members will still be able to withdraw the accumulated funds as a lump sum when they retire.
When the tax changes are implemented, the tax treatment of all retirement vehicles will be aligned. Furthermore, employer contributions to retirement funds will be taxed as fringe benefits in the hands of employees. The changes will also allow a tax deduction of up to 27.5% of the total remuneration relating to contributions to pension, provident and retirement annuity funds, subject to an annual cap of R 350 000. The deduction allowed is currently significantly lower.
“It becomes quite difficult to do a once-off calculation of how much you need to save to retire comfortably, given the variables such as rate of contribution, time frame, investment returns and potential legislative changes.
“Your financial adviser will be able to use a financial modelling tool to create the different scenarios, but it is only a starting point to facilitate the advice process and must be regularly reviewed,” says Möller.
A further move to encourage increased savings, which was introduced from 1 March this year, is the tax-free investment benefits of up to R500 000.
Möller says investors should take full advantage of the savings generated from the R30 000 allowed per tax year. The funds can be invested in interest-bearing vehicles like money market accounts or equities, and the annual returns and eventual proceeds will be tax-free.
Increased life expectancy
Other key issues like an investment strategy’s time frame are often overlooked in the planning phase. The most important aspect which needs to be taken into account is the fact that people are living longer and it’s a myth to think that your money only needs to last for an average 20 years post retirement.
“We are in an era where life expectancy of 100 years has become a realistic duration to plan for. Furthermore, expenses often rise in retirement, with more leisure time and activities such as holidays, eating out and expensive hobbies.
“It is important to be realistic in terms of how much you can draw each month and we advise not drawing more than 4 to 5% during retirement, to provide a low-risk path and to invest the remainder to deliver returns which at least exceed the annual inflation rate.
And it must be kept in mind that market volatility could dramatically change the picture.
“For example, a 10% fall in asset value when drawing an annual income of 5% off those assets, would require an 18% rise in the market the following year, while a 20% fall would require a 33% rise the following year to fully restore the portfolio’s full value.”
Old Mutual Wealth makes use of an advice-led, meaningful approach to clients’ personal needs and investment portfolios which includes a focus on integrated wealth planning and goal-based planning philosophies.