By Prof Matthew Lester (TaxTalk)
FOR years my simple philosophy on financial planning for young South Africans has been: get a degree, find a job, insure your risks, buy a house, pay off all your debts and then start saving and investing.
This philosophy meant not having to bother with the complexities of investments until in your 40s or 50s.
But I was young when Chris Stals was head of the Reserve Bank. The risk-free return for repaying a home loan was, at times, over 20% - tax-free. Today we are talking only 6% to 8%.
But still today, first thing every Monday morning I determine cash requirements for the week and adjust the home loan. Many South Africans do the same and, on average, home loans are repaid in about 12 to 15 years instead of the 20 years scheduled.
The return achieved by advancing the repayment of a home loan may be tax free, but it is not tax deductible. And, with home-loan rates almost equivalent to the inflation rate, the bond does not fall as spectacularly as it did in the past.
How about taking a sizable chunk of the home loan and putting that lump sum into a retirement annuity (RA) in February every year? Then allow the home loan to be slowly paid off over the 20-year period?
This makes for tax-deductible savings, which can be re-invested in the home loan until the following year and then recontributed to the RA.
The investment returns on RAs are exempt from income tax and capital gains tax. One can only hope that at some stage the world equity markets will recover, generating a return above the home-loan rate. If this is coupled with the reinvestment of the tax saving, the returns should be spectacular.
So, what’s the problem?
The beauty of saving through increasing your bond repayments is that the funds are readily accessible. With an RA, the investor has to wait until the age of 55 to access the funds.
Repayment of home loans is simple and inexpensive. Not so with RAs, where all sorts of fees are charged.
And, finally, do not lose sight of the Treasury’s proposals for retirement funds. The implementation of preservation requirements cannot be dismissed. And the future of the so-called living annuity cannot be guaranteed.