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These seven financial solutions should be used strategically

Putting financial solutions in place should be part of a carefully designed strategy. Each solution or product should serve a pre-determined purpose in your wealth creation strategy. As US investment guru Peter Lynch is famous for saying: ‘Know what you own and why you own it’. Here, we explore the mechanisms of seven financial solutions, who needs them, and what to know before implementing.

1. Retirement annuity

How does it work?

Retirement annuities are effectively personal retirement funds held in the name of an individual. As in the case of provident and pension funds, retirement annuities are registered in terms of the Pension Funds Act and are tax-efficient investment vehicles designed for individual investors and employees who wish to supplement their workplace retirement fund. South Africans are permitted to invest up to 27.5% of their taxable earnings towards a retirement annuity on a tax-deductible basis, making it a very attractive investment option. Investors have complete flexibility to determine their own contribution plan – with monthly, quarterly, annual, or ad hoc contributions being possible. With invested funds being inaccessible before age 55, investors can avoid the temptation of dipping into their retirement nest egg prematurely. New generation retirement annuities are typically housed on a LISP platform which provides full investment flexibility and transparency at very cost-effective rates.

Who needs one? Retirement annuities are ideal investment solutions for small business owners, self-employed individuals, or those who earn irregular income because the flexible nature of RA premiums. It can also be used by those who are formally employed and contributing to their employer’s retirement fund to boost their retirement savings. It is a particularly attractive vehicle for those who earn irregular income, commissions and/or incentives, or annual bonuses because the structure of the vehicle allows for as and when contributions to be made.

Be careful of: Be cautious of taking out an insurance-based retirement annuity as these can include penalties for early termination as well as an additional layer of costs, including upfront broker commission.

2. Tax-free savings account

How does it work?

Tax-free savings accounts are tax-efficient savings vehicles that are more appropriate for longer-term savings goals. This is because all proceeds earned from TFSAs – including interest income, capital gains and dividends – are exempt from tax, meaning that you get your full investment return without being taxed on the growth you earn. Unlike retirement fund contributions, it is important to bear in mind that contributions towards a TFSA are not tax deductible. TFSA investors are limited to investing a maximum of R36 000 per year, and a total lifetime contribution of R500 000, towards the fund. Where an investor does not use his annual contribution of R36 000 in a tax year, he will not be permitted to roll it over to the following year, and the contribution will therefore be forfeited.

Most Tax-Free Savings Accounts provide complete contribution flexibility, allowing investors to stop and start their contributions at will. Investors can choose to contribute monthly, quarterly, annually or on an ad hoc basis, although some providers insist on a minimum contribution level for administrative purposes. Tax-Free Savings Accounts can take the form of money market or fixed-term bank accounts, a unit trust investment or a JSE-listed exchange traded fund. TFSAs can be issued by banks, long-term insurers, unit trust managers, mutual banks or cooperative banks.

Before investing in a TFSA, it is important to understand the longer-term implications of doing so. Any withdrawal made from a Tax-Free Savings Account is deducted from the investor’s lifetime contribution limit. So, if an investor has R200 000 saved in his TFSA and makes a full withdrawal, he will only have a remaining lifetime contribution of R300 000. Further, the annual contribution limit of R36 000 per individual is strictly enforced, and any contributions in excess of this annual limit can be subject to penalty tax of 40% of the excess – keeping in mind that the onus is on the investor to keep track of their contributions.

Who needs one? Anyone who is already maximising their tax-deductible contributions towards a retirement annuity should consider contributing towards a TFSA in order to take advantage of the tax breaks. A TFSA is also an excellent way to save for your child’s education, keeping in mind that in order to reap the full benefits of this investment, a minimum ten-year investment horizon should be contemplated.

Be careful of: If you take out a TFSA in your child’s name, you will effectively be using up all or part of your child’s lifetime contribution which, in turn, will affect your child’s ability to save tax-free later on in life. Rather set the TFSA in your own name and earmark it for your child’s future use.

3. Income protection benefit

How does it work?

In a nutshell, income protection is a long-term insurance benefit designed to replace or supplement your income in the event of illness or injury which temporarily or permanently prevents you from earning an income. While you may not perceive this to be a risk, bear in mind that the risk of a temporary illness or injury is much greater than the risk of dying, becoming permanently disabled, or contracting a dread disease. Importantly, keep in mind that an income protection benefit is not designed to pay out in the event of retrenchment. The premise of an income protection benefit is that it is designed to ensure you can maintain your standard of living and that you can at the same time save towards your retirement. While most income protectors end at age 65, some insurers allow you to purchase cover up to age 70, 75 or even ‘whole of life’ in some instances – for which you would naturally pay a higher premium.

Who needs one? Anyone who is generating an income and who does not have sufficient invested capital to fund for their ongoing living expenses in the event of a temporary or permanent disability should ensure that their income is adequately protected. 

Be careful of: When taking out an income protector, pay careful attention to your waiting periods. A waiting period of three months means that you would need to be unable to work for a period of three months before claiming, and you need to ensure that you have access to sufficient capital to tide you through this period.

4. Gap cover policy

How does it work?

Gap cover is short-term insurance cover designed to cover the difference between what your medical specialist charges and what your medical aid covers – known as the ‘gap’ – and is generally applicable to treatment received while in hospital. As top-up health insurance, gap cover can play an important role in your overall portfolio by protecting you against high, unforeseeable medical expenses which are in excess of what is covered by your medical aid. There are a large variety of gap cover providers and policies available in the marketplace ranging from entry level benefits to more comprehensive benefits that includes cover for co-payments, oncology, diabetes, scopes, scans and emergency care.

Who needs one? If you’re on a very comprehensive medical aid and have a sizeable emergency fund, a gap cover policy may not be a priority for you. However, generally speaking, it is ideal that every member of a medical aid puts a gap cover policy in place as additional protection against sizeable medical expenses.

Be careful of: Don’t delay putting a gap cover policy in place. Many gap cover providers have an age limit of between 60 and 65 meaning that, as you age, the available gap cover options available to you will reduce.

5. Emergency fund

How does it work?

An emergency fund is a specially earmarked sum of money that is easily accessible and that can be used to help cover unforeseeable, high-cost expenses which, in its absence, could have catastrophic effects on your financial position. Whether your emergency fund is housed in your access bond, a separate savings account, or in a fixed deposit account, be sure that the funds are clearly earmarked for emergency expenditure. Keep in mind that, given the nature of emergency situations, you will need immediate access to your funds because any delay in being able to access your money could result in you having to access debt, which can be expensive even over the short-term.

Who needs one? Everyone needs immediate access to cash, although the amount of cash needed depends on a person’s unique set of circumstances.

Be careful of: Ensure that your emergency money does not serve multiple functions in your portfolio as this could result in the funds being unavailable when an emergency arises.

6. Unit trust portfolio

How does it work?

Unit trusts, or collective investment schemes, are well-suited to a wide range of investment objectives, and provide an economical way to invest any quantity of money whilst still obtaining the same level professional management and diversification of investment. The administration, management and sale of unit trusts is regulated by the Collective Investment Schemes Control Act. Distinct advantages of unit trusts are that they may include professional portfolio management, the ability to diversity a portfolio cost-effectively, relatively low transaction costs and the ability to buy and sell at will. As the owner of unit trusts, you are essentially a unit holder in a fund that invests in a range of assets, including shares, property, bonds and/or money market instruments, depending on the mandate of the fund.

Who needs one? A well-diversified unit trust portfolio can play a vital role in achieving one’s medium to long-term investment goals and can be used to create much-needed cashflow in one’s retirement years.

Be careful of: Remember, the sale of any unit trusts will trigger a capital gains event, so it is important to do your calculations before selling any units. When you switch between unit trusts or withdraw, you effectively trigger a capital gain or loss, and 40% of your capital gain will be taxed at your marginal tax rate with the first R40 000 per tax year being tax exempt.

7. Living will

How does it work?

A living will is a separate, standalone document that provides guidance to your family and medical doctor regarding end-of-life medical care and treatment. In your living will, you can request that medical treatment that would prolong your life be withheld in circumstances where you are in a permanent, vegetative state, irreversibly unconscious, or where there is no hope of recovery. In your living will, you can also document your desire to donate your organs and/or tissue and appoint a medical proxy to speak on your behalf if you are unable to.

Who needs one? Anyone over the age of 18 who is compos mentis can draft and sign a living will. If you are concerned about being artificially kept alive indefinitely even where there is no hope of recovery, it is advisable to put a living will in place.

Be careful of: Do not keep your living will stored together with your last will and testament as you run the risk of the document being found only after your death. Instead, let your medical practitioner and your spouse keep a copy of the document so that it is easily discoverable should tragedy occur.

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Gareth Collier

Crue Invest (Pty) Ltd

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