Should I use most of my provident fund as capital in a new business?

Quantify the business risks: this represents the majority of your pension, and you don't have time on your side to build it up again.

I am 58 years old and in good health. I have a provident fund of close to R6.6 million. I am planning to leave my current job and want to buy a well-established guest house in Graskop for R3 million using money from my provident fund. The guest house has had an average turnover of R900 000 per year over last three years. 

I know I have to pay tax when I cash in my provident fund, so this means I will need to cash in more than the R3 million. Is it a good thing to use most of your provident fund as capital in a new business? It will at least give me steady income over the next 15 to 20 years before I final retire.

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There are several factors which need to be explored in detail in order to help you with an analysis of your options and the potential risks associated with those options. Due to the scope of this response I would recommend that you explore this in further detail with a professional financial advisor.

Assumed tax on withdrawal?

In order to try and quantify the gross withdrawal amount that is required to generate the R3 000 000, I have used the Allan Gray withdrawal tax calculator. I made the assumption that you haven’t taken any previous withdrawals or benefits.

In order to generate R3 000 000 net of tax, you will need to withdrawal approximately R4 500 000 which equates to 68% of your provident fund.

Investment time frame

Under the guest house scenario, your stated investment time frame before retiring is 15-20 years, but be aware that this is also “health dependant”. This is potentially a long period of time. I assume that your current employment provides for a retirement age of 65, being in 7 years’ time.

On the one hand, if you leave your provident fund to grow and compound over the next 15-20 years, depending on your risk profile and underlying investments, it could achieve a pleasing return over the period. Once you retire in perhaps 7 years’ time you can generate an income from the provident fund. This assumes that you continue to earn an income from your current job until then.

On the other hand, if we assume that you are able to buy the well-established guesthouse and run a successful business over the next 15-20 years whilst leaving your remaining R2 100 000 to compound in a provident preservation fund over that period, it may be a worthwhile investment.

Quantifying the business risk

The largest unknown factor in the equation is the business risk that is associated with running the guesthouse.

Points to consider:

  • Do you feel comfortable that you are able to run a successful guesthouse business? Do you have any experience in this industry or in business generally?
  • Will the business require any addition capital over the next several years? Additional capital requirements may be an unforeseen burden on your cashflow.
  • Of the R3 000 000 what percentage of the sale price consists of physical assets such as the guesthouse itself (assets which you could sell in the event that the business is unsuccessful) and what percentage is based on the profitability of the business?
  • Economic risk. What if the consumer falls under more financial pressure and you see lower turnover?
  • How flexible will your overheads be should you need to run the business as lean as possible for a period of time?
  • Do you have a business plan to increase turnover?

I recommend that you try and quantify the business risks to the extent possible. This can be achieved through a business plan and cashflow projections based on several scenarios e.g. best case scenario, worst case scenario, realistic scenario. Bear in mind that its unlikely that you can afford to take a big knock on this because it represents the majority of your pension, and you do not have time on your side to build it up again.

Alternative considerations

You may consider the possibility of raising a bond for a portion of the sale price. Interest rates are relatively low. Raising a bond comes with its own set of risks particularly if the business doesn’t have a consistent and reliable cashflow to provide for overheads as well as the bond repayments and a living wage.

It is worth exploring this option to see what the financial implications are should you raise a bond against the property to fund a portion of the sale price.

  • What interest rate would you be able to secure?
  • What would the term be?
  • Are the monthly repayments feasible given your analysis of the business plan and cashflow predictions?

Summary

Given your age, it is important to recognise that should you venture into a business with the proceeds from the withdrawal of the majority of your pension fund as your start-up capital and the business is unsuccessful, you could find yourself in very concerning financial position.

If you are comfortable with the business risks and the sale price, then it may be worth considering raising a small bond on a portion of the sale price which must be built into your cashflow.

Do you have any questions you would like answered by registered financial planners?

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