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How should a 23-year-old invest their money?

Q:
Is a retirement annuity, unit trust, or tax-free savings account the way to go?

I’m 23 and I’m trying to understand how to plan my life financial. I’ve just started my first professional job and am making enough to put away some money every month. My initial plan is to try and max out a tax-free savings account contribution for the year. This is currently at a traditional bank. After I’m able to build up a bit of capital, I will move it across to a unit trust in the next year or so. 

Furthermore, I’ve been doing a lot of freelancing work, which at the moment is just extra pocket money. I have saved up quite a large sum, which I would like to either put down as initial capital for a retirement annuity, which I will then contribute to monthly. Unfortunately, the company I work at does not have a company RA. Am I on the right track? Should I start an RA or rather open another unit trust? 

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Dear young professional reader,

Congratulations on taking charge of your financial destiny so early in your career! It is one of the best things that you can do for yourself.

From the information provided it appears that you have already set a budget. This is the first and most important step to financial independence. A budget tells your money where to go instead of you wondering where it disappeared to. It also tells you how much you need every month to live the lifestyle that you choose. This amount will guide you during the planning process.

Once you know what amount you need every month, the next step is to set up a reserve or emergency fund. The funds should be available on short notice as emergencies usually arrive without notice! The amount that you should have available in an emergency fund is three to six times the amount that you need according to the budget that you have set.

As individual tax payers enjoy an annual exemption on all South African interest earned, you could hold funds in a Money Market Fund. For the 2019 tax year the exemption is R23 800 for individuals under 65 years old and R34 500 for individuals 65 years and older. You should therefore be able to hold sufficient funds in a reserve fund without having to pay tax thereon.

Once you have a reserve fund, you can start to invest. Tax-free savings accounts and retirement annuities are both excellent investment vehicles as both are exempt from income and capital gains tax on the investment returns earned.

Contributions to a retirement annuity can be deducted from your taxable income. The deduction is, however, capped at a rate of 27.5% of the greater of remuneration and taxable income, subject to an annual limit of R350 000.

It is normally better to exhaust your retirement annuity limit before you start to invest in a tax-free savings account. The contributions to a tax-free savings account are not deductible and you are limited to contributing up to R33 000 per annum. Although a tax-free savings account should form part of a long-term investment strategy, you will be able to withdraw from this investment in need. Unfortunately, if you have invested the maximum amount during a tax year and you withdraw funds during the same year, you will not be able to top it up to the limit again that year.

It is also important to keep track of your contributions as Sars will levy a penalty of 40% on the amount in excess of the annual limit.

Both investment vehicles will allow you to invest in unit trusts. Retirement annuities have restrictions as far as the allocation of asset classes are concerned (Regulation 28), but tax-free accounts do not. A tax-free account could therefore give you more exposure to equity or offshore funds should you need to include same in your portfolio.

Because you are building wealth, you should also draft a will and get into the habit of reviewing it annually when you review your investment portfolio as personal and financial circumstances do change.

  

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