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Cape Town - Abraham van der Westhuysen, advisory partner at Citadel, suggests that having a financial plan is the first step to a good retirement.
Van der Westhuysen takes a look at the vital financial planning aspects that should be considered, as well as the common mistakes investors make, before retirement.
Understand the fee breakdown
Understanding how one’s fees are allocated to the portfolio is essential, as additional fees may be responsible for fewer savings during retirement.
Always ask for full disclosure of fees inclusive of fund, administration as well as advice and management fees.
Ensure that there are no initial and/or ongoing fees being paid to the advisor from the fund level. Similarly, brokerage fees should be discussed for a stock broking portfolio.
Consider the withdrawal rate and tax effects
Assessing whether one has sufficient savings to support one’s retirement lifestyle, is essential.
It is important to determine a realistic and sustainable withdrawal rate from the retirement portfolio, so that the savings are able to last throughout the retirement phase.
During retirement, a person would either receive a fixed income or have the opportunity to elect a withdrawal rate once a year. Currently, individuals can withdraw the full value of their provident fund and only one third of the value of any pension fund or retirement annuity.
This legislation is changing from March 2015 as one would no longer be allowed to withdraw the full value of a provident fund.
Current legislation allows for the first R500 000 to be withdrawn without incurring any tax upon such withdrawal, the following R200 000 at 18% tax payable, the R350 000 thereafter at 27% tax payable and any lump sum amounting to a greater amount than R1 050 000 will be taxed at 36%.
Here it is important to assess the effective rate of tax paid on the lump sum as the future retirement income will be taxed at your marginal tax rate.
Legacy planning
The allocation of a retirement portfolio should incorporate legacy planning.
In light of a total investment portfolio, consider what the allocation of the retirement portfolio should look like from both an asset as well as geographical point of view.
A holistic view has to be taken on the total portfolio to assess this allocation and this should also incorporate legacy planning. Consider whether you will remain in South Africa once in the retirement phase:
- Where do my beneficiaries currently reside and do they have any intention of leaving South Africa?
- Do I have sufficient global allocation in my current portfolio?
- How liquid is my current portfolio excluding my retirement portfolio?
- Do I have any other income generating assets to supplement my retirement income and how liquid are these assets?
Mitigate risk by taking into account inflation
The most common mistake people make is not taking inflation into account when assessing future financial need.
Without an equity-like driver in an investment portfolio, beating inflation will prove tough on an on-going basis. Financial planning and category allocation therefore become crucial.
Thorough category allocation should be applied on the portfolio construction in order to mitigate volatility risk.
In understanding the withdrawal need from a retirement portfolio, one could mitigate investment risk by applying category allocation.
Quantify the first two to three years’ worth of withdrawal need and allocate this to stable assets and furthermore, accordingly allocate the following three to four years’ worth of need to prudent assets.
The remaining assets can then comfortably be allocated to long term volatile assets, as sound planning around the withdrawal need has already been applied.
Emotional decisions can harm your retirement savings
A good rule of thumb is to invest 15% (worst case scenario) to 20% (best case) of one’s income into a retirement vehicle pre-retirement.
These funds can only be accessed post-retirement and this will prevent emotional decisions being responsible for one to withdraw from one’s retirement savings. The best way to mitigate such risk is sound financial planning.
- Fin24
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