In this advice column Jamey Lipschitz from Sanlam Private Wealth answers a question from a reader who wants to know what to do with his share portfolio when he retires.
Q: I have a portfolio of blue chip shares worth around R7 million. I am 63 years old and will have to start using some of my savings to sustain me and my wife in three years time.
My concern is whether I should stay in shares or should I sell and invest in something else? I am worried about what the markets are doing, and need some peace of mind.
I will need around R700 000 a year, and I have some annuities as backup.
There are a number of important issues that someone in this position would need to consider.
Firstly, South Africa and most of the world is in a low-yield environment at the moment. Some countries are actually providing a negative yield on cash investments for the first time in history.
This has forced investors into higher risk asset classes like equities and property for the relatively higher yield they provide. At the same time, however, this has pushed up the valuations of these asset classes and many are now considered expensive. In turn, the relative yield on these asset classes have come under pressure as the prices have increased.
Secondly, even the current situation notwithstanding, equities are considered high risk compared to other asset classes. It is therefore important to establish what percentage exposure to equities is appropriate based on an investor’s risk profile and income requirements.
There are periods when equities do not perform and one must be able to stay invested for the long term and not be a forced seller for income purposes. This will ensure that one derives the full upside and value.
Thirdly, the dividend yield on South African equities is currently approximately 3%. That means that a R7 million equity portfolio would yield around R210 000 per annum. That is a shortfall of R490 000 every year on the R700 000 income required.
There are certain equities that provide a higher yield, but making changes will potentially incur capital gains tax and brokerage charges, which will lower the overall value of the investment. One must also consider the 15% tax on dividends when calculating the income that one will be receiving.
Fourthly, other asset classes like preference shares and bonds provide a higher income yield, however, their potential for capital growth is generally more limited than equities over longer periods. Bonds (fixed income) are also taxed at the investors’ marginal rate (potentially 41%) as opposed to the 15% tax on dividends for preference shares and equities.
The short answer to your question is that you will be paying R191 820.51 tax on a retirement fund value of R947 113. In other words, 20.25% of your retirement benefit will be paid to the South African Revenue Service (Sars).
How this is calculated is that your capital will be taxed on a sliding scale. The first R25 000 is tax free, the next R635 000 will be taxed at 18% and the balance will be taxed at 27%. Although not relevant in this instance, any amount over R990 000 would be taxed at 36%.
However, you can avoid this tax entirely by transferring the benefit to a preservation fund. This is an option you should seriously consider.
A preservation fund works in the same way as a retirement fund, except that you don’t have to keep contributing to it. You will be able to make one withdrawal from this fund before your retirement date, but otherwise you won’t be able to access the money until you turn 55.
Once you retire from the fund, the first R500 000, less any amount you have already withdrawn, will be paid out tax free. At this point you can withdraw up to one third of the capital as a lump sum if you like, but the rest must be used to arrange a monthly income during retirement. You will be taxed on your monthly income according to Sars income tax tables.
Why this is particularly important is because if you withdraw your retirement capital now, the R500 000 tax-free benefit that you would receive when you actually retire will fall away. So you will be suffering a double tax penalty.
Apart from the tax you will have to pay now, you should also consider the important differences between putting the money into a preservation fund and taking it out to invest yourself.
A lot of people who get a bonus or once off additional income for whatever reason, tend to ‘blow it’ as you have pointed out. It is therefore a very good idea to try to think of better things to do with the money. I would, however, suggest that you consider not only your immediate or short term needs but also the long term potential of any extra income you receive – no matter how small.
If you have a need for extra monthly income, which might be the case if you are currently using a credit card or overdraft because your expenses are close to or more than your current monthly income, then I support your idea of putting the money in a vehicle that will allow you to supplement your income for the next two years.
A two year term, however, is a very short time horizon for an investment and I assume you intend to be drawing the full amount over the two years. In other words, you will be left with nothing at the end.
If so, you will need access to the money and very little, if any, risk. With these constraints in mind, I would suggest either multi-asset income unit trusts – the top funds produce between 8% and 10% per annum historically – or a bank savings, call or money market account with cash immediately available. These bank accounts produce between 5.5% and 7.5% per annum, depending on the amount.
Let’s use an example and say the amount is R50 000. If you can achieve returns of 10% per annum for the next two years, this will produce an income of R2 307 per month for 24 months before being depleted. At 7% per annum, the monthly amount will be R2 194 per month, so there is only a small difference, which means it is probably not worth taking the extra risk.
The question is whether you actually need additional income or if you are just going to be spending it over 24 months instead of one month. If you don’t really have a requirement for the additional income, you may want to consider investing the amount for a longer term so that it can produce even more for you.
You could consider putting the money into a tax-free savings account or retirement annuity (RA). By contributing to an RA, you would be reducing your taxable income. This means you could get something more back from the South African Revenue Service next year, depending on what retirement contributions you are already making.
Let’s use the same R50 000 we used for the example above and assume that you are below the maximum deductible contributions to your retirement funding. This is currently 27.5% of your remuneration or taxable income, or R350 000 per annum, whichever is lower.
Let’s also assume that you are in a 36% tax bracket. If that is the case, you would get an additional R18 000 back from SARS or have to pay in R18 000 less for income tax when you submit your next return. In other words, you receive your R50 000 dividend, you invest it into an RA which results in you having an extra R18 000 next year, and the R50 000 also grows until you retire. You can only access the money in an RA once you turn 55.
The tax free savings account option wouldn’t allow you to deduct contributions for tax, but it also doesn’t tie the money up until retirement. Taking into account that growth and income in the investment is not taxed, you can benefit hugely if you think of it as an additional retirement savings plan.
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Source: earning income at home
How to Pick a Binary Options Broker There are many different business ventures in which someone can get into, meaning, there are many options in which one can take, when looking for the best business, you need to consider what you would expect from it, meaning, you will have to look for the best means to making sure that everything will work as intended and also that you get to be satisfied, meaning that you will not be wasting your time or even resources. Therefore, some of the things that someone can do is look into the binary options market, in this, you will need to look for a broker, meaning someone who will be able to give you some accurate information so that you can have the best returns possible, this means that eventually, you will get to find some of the best means to making sure that indeed you will be able to move forward. Amongst the things which you will have to do is getting to make sure that indeed you have conducted an assessment or a research, this will ensure that you can find the best expert available, that is, a broker who will aid you in knowing the way forward and also making sure that you can be contented, therefore, it will be the simplest means, to begin with since, by this, you can look into their reputation.
Practical and Helpful Tips: Options
The assessment, therefore, will need you to have some resources, since within the business you get to use the internet, you can use the same means to look for your broker, meaning that the internet will have ample information in which will ensure that you can know of the best ways or means to making sure you can succeed or even get to find the best binary options, broker.
Practical and Helpful Tips: Options
On the other hand, the transparency is something which you will need to look for in a broker, this means that you will have to look for a broker who will be willing to disclose all the options to you, meaning that you will have all the information in what it is that you would stand to make and also what you might lose, this will make your decision-making way much better. Likewise, you will find that most of the transactions are conducted online, meaning that, you get to find the best means to making sure that indeed you can be contented, to do so, you can request or even look for a broker who has some demo accounts, meaning, you will get the thrill of the real account for a while thus being able to make a conclusive decision if you would like to proceed with the broker or not.
Sanlam Employee Benefit’s head of special projects David Gluckman penned the following in response to a recent article published as part of a Sygnia marketing campaign.
“Consistency is the only currency that matters” is a well-known slogan of one of South Africa’s leading asset managers.
At the other end of the spectrum, a new player entered the commercial umbrella fund market less than 4 months ago proudly announcing “one all-in fee as a percentage of assets under management” and illustrating projected cost savings to clients adopting this model versus the competing leading commercial umbrella funds. Besides some fees such as costly hedge funds being over and above the so-called “one all-in fee”, importantly all these projections assumed there would be no need to separately pay for the services of a consultant. Today the message is slightly different and we should now understand that these projections were never accurate in that the true intention was always to leave “financial room for the employment of independent consultants.”
But the new player does raise some valid questions as regards the most appropriate governance model for commercial umbrella funds. These questions are important given the massive growth in this market (see graph below).
Two recent experiences highlighted to me that a very important question to explore is what will in the future be the role of the consultant in commercial umbrella funds.
- One highly respected independent consultant to a large book of Sanlam Umbrella Fund clients (and who also has many clients participating in other major commercial umbrella funds) raised the issue with me at our 2016 Sanlam Employee Benefits Benchmark Symposium, and said he is worried about the sustainability of his business given the increasing power of the major commercial umbrella fund sponsors.
- Various senior Financial Services Board officials also raised the matter in an April 2016 workshop with Sanlam Umbrella Fund representatives, essentially asking whether consultants introduce an extra and unnecessary layer of costs. They wanted to explore whether Sanlam could instead provide these advisory services thus savings costs for the ultimate clients of umbrella funds being the members.
The Sanlam Umbrella Fund governance model was structured consistently with thinking as set out in my paper entitled “Retirement Fund Reform for Dummies” presented to the Actuarial Society of South Africa as far back as 2009. In that paper I argued:
“The role of intermediaries (aka consultants) requires particularly close scrutiny. I would argue their role is a particularly vital one if we want to create a culture of effective competition.
Rusconi argues “In the institutional space, however, savings levels are less likely to change and marketing is more about attracting another provider’s customer than about motivating additional savings”.
Such arguments emanate from the premise that intermediaries do not add value to consumers – an assertion that I would challenge. My view is that there are both good and bad intermediaries, and we need to find a model where market forces will push in the direction of forcing intermediaries to continually “up their game”.
I am regularly asked for advice by younger people looking for a sure-fire way to build their wealth. They are often surprised when I tell them to invest more time and money in themselves and their human capital. Historically, people who do this are likely to create significantly more wealth over their lifetime than those who don’t. It is obvious that you need to accumulate investment assets but you also need to ensure that you earn income at an increasing rate over your career. The best way to do this is by investing in yourself.
What is human capital?
Human capital is the combination of skills, knowledge and abilities you have that will enable you to generate income over your working life. Nearly all of us have an ability to generate some income but very few people consistently invest in themselves so that they can increase their earning potential over time. According to the Federal Reserve of San Francisco, university graduates generate R16 million more income over their careers than non-graduates. This might give some context to the #feesmustfall campaign in South Africa.
If you choose to invest in yourself, you need to ensure that your skills and knowledge remain relevant and adaptable to changing economic conditions and an evolving business environment. You should regularly review whether you need to add to your skills or knowledge-base. Additionally, you need to be honest enough with yourself to be able to decide if you need to change careers if you are in a dead-end street. For instance, I would not consider newspaper printing as a long-term career option!
Specialise but not too much
Some careers reward those who specialise but one should always be careful of becoming too narrowly focused in your career. For example, deciding on an academic career researching the mating habits of albino penguins in the Southern Cape might not ensure a long-term income. However there might be less risk in being the orthopaedic surgeon who specialises in surgery of the shoulder in South Africa. Many young people strive to be a manager in a large corporate. This might be the most risky career choice one can make. Managers are essentially generalists and are often the first people to be fired in a merger or downsizing. If you plan to work in a corporate, you might do better focusing on being a revenue generator or product specialist.
Not only for academics
If you are not academically inclined or you have no interest in tech, you could always consider specialising in old world industries. There is a massive shortage of plumbers, electricians and general handymen. Now that more people work in services industries, there are many fewer people who can work with their hands. This provides an ideal opportunity for reskilling yourself if you have the inclination.
In this advice column Riette Coetzee from Alexander Forbes answers a question from a reader who wants to know whether he really needs a financial advisor.
Q: I will be going on pension at the end of this year at the age of 65. I have no debt and my home is paid for.
I have been involved with four different financial advisors, but cannot get away from the exorbitant costs that are involved. I have my pension and a separate retirement annuity (RA) and about R2 million in cash which they all would love to invest for me. I am left with the impression that they could invest my money to earn about 1.5% per annum more than I could, but since their fees will be 1%, it hardly makes it worth my while.
I now seem to think that my best option is to take my R500 000 tax-free allowance from my pension and draw down the minimum of 2.5% on the rest. If I subsidise myself from my cash reserves, I can survive for the first six years of my retirement while still leaving the rest of my pension to grow. I would not even have touched my RA yet.
However I’m still wondering if I would be better off investing the cash amount through a financial advisor?
To answer this question, we need to take a step back. Before you can decide what you want to do with your money, you need to know what you want to do with your retirement.
One person’s retirement dreams are very different from another’s. For some it is to slow down, but for others it is to do the things that your working life never allowed you to do.
At your age a financial plan should support your remaining life plan and lifestyle. Your financial plan is one component of a flexible life plan that will need to see you through from your mid 60s into your late 90s.
Bear in mind that if you manage your investments yourself, you need to set aside the time to monitor your portfolio and be disciplined to adjust to different market conditions. You also have to keep your emotions in check when markets are volatile. These demands and complexities of successful investment management can prove challenging, even for the most informed individual investor.
People everywhere are also living longer. You therefore have to consider the long-term implications of managing risk, your money, tax and liquidity.
In addition, we live in very uncertain times. The IMF has cut South Africa’s 2016 growth forecast to 0.1%, foreign investment in the country has dipped to its lowest in ten years, a credit downgrade is still on the horizon, and there are still uncertainties around Brexit and Chinese growth, to name only a few. Getting the right financial advice to manage these risks is more important than ever.
A professional advisor will help you set up different investment strategies to achieve certain financial goals and provide assistance and guidance with retirement and estate planning. Competent financial advisors are knowledgeable about financial markets, investing landscapes and tax implications.
Calculations compiled by Itransact suggest that if an amount of R100 000 was invested over 20 years at an investment return of 15% per annum (inflation is an assumed 6%) at a cost of 1%, the investor would lose 17% of his returns as a result of fees. If costs climb to 3%, the investor would sacrifice almost 42% of his returns.
Unfortunately, it is not always that easy to get a clear sense of what you pay and what it is you pay for, but the introduction of the Effective Annual Cost (EAC), a standard that outlines how retail product costs are disclosed to investors should make this easier.
Shaun Levitan, chief operating officer of liability-driven investment manager Colourfield, says the time spent looking around for a reduced cost is time worth allocating.
“I think that any purchase decision needs to consider costs, but there comes a point at which you get what you pay for.”
You don’t want to be in a situation where managers or providers are lowering their fees but in so doing are sacrificing on the quality of the offering, he says.
“There tends to be a focus by everyone on costs and [they do] not necessarily understand the value-add that a manager may provide. Just because someone is more expensive doesn’t mean that you are not getting value for what you pay and I think that is the difficulty.”
Costs over time
Despite increased competition and efforts by local regulators to lower costs over the last decade, particularly in the retirement industry, fees haven’t come down a significant degree.
Figures shared at a recent Absa Investment Conference, suggest that the median South African multi-asset fund had a total expense ratio (TER) of 1.62% in 2015, compared to 1.67% in 2007. The maximum charge in the same category increased from 3.35% in 2007 to 4.76% in 2015. The minimum fee reduced quite significantly however from 1.04% to 0.44%.
Lance Solms, head of Itransact, says the reason fees remain relatively high, is because customers are not asking active managers to reduce their fees. He argues that it is easier for investors to stick to well-known brands, even if they have access to products that offer the same return at a cheaper fee.
And despite a flood of communication regarding fees, intermediaries are not yet as sensitive about costs as one would have hoped, Kellerman adds.
But there are also other factors to consider.
Although more rigorous regulatory oversight in itself is not necessarily a bad thing, compliance requirements have resulted in significant cost implications for the entire value chain, Kellerman says.
Advisors are frequently asked this question. This often has more to do with personal risk preference than with economic rationality. To answer this question, however, certain assumptions must be made, and I specifically won’t look at tax to keep the answer succinct.
The rational answer
Let us assume that the interest rate on the bond is at the prime lending rate. That is currently 10.50%
The second assumption we need to make is about what the risk level of the unit trust in question is. A money market unit trust has a very different risk and associated return goal than an equity unit trust.
A low-risk money market or income fund aims to beat inflation and offer a real return of 1% per annum. Thus, if the R100 000 is in an income unit trust only yielding 7% to 8%, it would be rational to secure the higher guaranteed return of 10.5% and transfer the funds into the bond.
However, if the money is in a balanced fund which generally targets a 5% real return, it would be more rational to remain invested as the real return is in excess of the bond interest rate.
It is also important not to fall into the trap of looking at the short-term underperformance of equity linked funds in a time like now and compare this to a resilient prime rate. This may result in the wrong decision to sell out at the wrong time. Every situation is unique and the best course of action is to get advice from a financial advisor who will look at the big picture and your individual circumstances.
The subjective answer
The other way I would advise a client on this is a more subjective approach – the sleep test. Quite simply, what makes you sleep better at night? Would that be a bond balance of R100 000 lower than it is now with no funds invested, or the same outstanding bond balance but R100 000 invested?
The answer will be different for each individual and there are a lot of factors that influence one’s financial decision making such as your view of debt as either toxic or as an enabler. For some people having R100 000 invested offshore, for example, gives them comfort. Therefore, because the economic rationality argument is often such a close contest, considering the subjective approach may help make the final decision easier.
The reader states that they are entitled to R5 047 648 as a resignation benefit. For purposes of this comparison, the impact of tax on this amount has not been considered as this could vary by individual.
Let us assume that this money will be invested into a living annuity-type structure in order to provide a retirement pension. Under this scenario, the lump sum is invested and a pension is drawn from this balance for as long as the balance is positive.
To put it simply, this operates similar to a bank account. The account increases with investment returns and reduces by any amount that the reader withdraws in the form of a pension.
It is important to realise that the reader will be assuming both the investment and longevity risk under this scenario. Poor investment performance will impact on the amount of pension that the reader may be able to withdraw. Additionally, if the capital is fully eroded while the reader is alive, no further pension will be payable. However, on death, the balance of the account can be paid out to the spouse or other dependants.
Comparing the two
If we consider this reader’s particular circumstances, in order to match the R27 414 per month pension from the GEPF, they would need to draw 6.52% per annum from the living annuity balance.
For illustrative purposes, we assume that the account balance would grow at 10% per annum and that the reader would require the annual pension to increase in line with inflation at an assumed 6% per annum. Under these assumptions the investment growth on the account will exceed the pension being drawn for around nine years. After that the capital will start to be depleted and will be fully eroded after about 22 years.
Assuming that the reader is 60 years old, it is estimated that the capital will be fully eroded by age 82. If, on average, the account grows by less than 10% per annum, this amount will be eroded sooner. Thereafter, no pension will be available. This illustration demonstrates the investment and longevity risks the reader faces.