2020 will be a year to remember. Unfortunately, not for all the right reasons. The year we find ourselves in the middle of a pandemic, that has changed the world. However, with every thunderstorm, much needed rain follows. The silver lining in these dark clouds, is the value that can be mined with markets at low prices. The best time to invest is when markets are at the weakest.
However, there is also financial strain. Unemployment is climbing in South Africa and globally. We are looking at the possibility of it even reaching 50%. That is a scary figure. A lot of employees are facing, salary cuts, short time or retrenchments. There is an increase in the number of businesses cutting back or closing their doors. The dilemma most of us face as individuals or as entities, is lack of accessible savings to carry us through these tough times. It is a valuable lesson we should take heed of. It also leaves us looking at a potential of gold, in the opportunity the markets have, with little means to invest, if we do not have the funds available.
The harsh reality is that there is no end in sight in the short term to this pandemic and its consequences. And, it will not be our last financial challenge faced. But, lets be wiser going forward. The lesson learnt, is the value of putting funds away for that rainy day. Also, structuring your portfolio to protect yourself from creditors.
Being tax efficient I suspect will be part of that lesson in the year ahead. I say that as I believe there will be austerity measures government will need to put in place, to fund its Covid relief measures, in the next tax budget. Nothing is for free. This itself will burden the economic recovery needed to pull us out of the crisis we find ourselves in.
Bank and creditors offer relief for those in financial strain without savings. But one must be careful when taking these measures unnecessary. If you can cope without it, then try not use it. Reason being, that while they help in the short term, they add to the long-term debt trap. Whether its interest the institution charges or extending the term of the finance, it means you paying interest and not earning interest. Remember, in the next few months when the “relief period” ends, the debt will be increased, and the normal monthly requirements will return but not the availability of funds.
On the Insurance side, the various institutions do offer a “holiday break” from your monthly contribution for your portfolio. But not without consequences. On the Risk benefits such as life cover, disability and dread disease, your can stop the premiums or reduce it, but so does the cover reduce or stop. On the investment side, you can do the same. The difference is that your full capital should still fully available at market related pricing, it does not stop or reduce in value if you stop or reduce the premiums. Unless it is a life product that may have a penalty. But LISP wrapper products will not have any penalties. But most institutions will waiver or reduce the penalties during these times. To find out more, chat to your advisor or call the relevant call centre to confirm.
Living Annuities are also currently allowing one to increase your drawings to 20%, which is normally capped at 17.5% per annum. And you can do so during this Covid period, even if your anniversary date is not due yet.
On the short-term insurance side, some Insurers will reduce the premium, but then the excess during claim stage will be higher. On the medical aid side of things, you can reduce your medical aid to a lower plan, you do not need to wait till the end of the year. But you cannot go to a higher plan till the end of the year.
I would strongly urge that with all these products you sit with your financial advisor and discuss it. There are implications that you need to be aware of.
On the planning for future crisis and financial strain, there are two things to consider. Accessibility and protection from creditors. Investment products are broken down into two categories, discretionary and compulsory.
On the Compulsory side, these are monies towards retirement savings. Usually only accessible at age 55 or older. The exception is Preserver Funds. Preservers offer a once off withdrawal access before age 55, but the proceeds are taxed as per early withdrawal tax tables. You do have a once off tax free portion of R25K across your overall portfolio, the balance is taxed as per retirement withdrawal tables.
The three advantages of these products are that they tax efficient is that there is no tax within the product and contributions are tax deductible at a rate of 27.5%. A preserver does not allow for additional contributions. The other two advantages are that it allows for a beneficiary, so it does not draw executors fees unless the estate is the beneficiary. And lastly it is protected from creditors.
But the advantages come with one disadvantage, being accessibility. These are not product for short term needs or for emergency funding. They meant to provide for retirement in a tax effective manner.
If you are looking for a savings vehicle that can cater for hard times such as these we are going through, then you need to look at discretionary savings. This comes in the form of one of 4 products. That being:
- An endowment
- A unit trust
- A bank product like a Money Market or Fixed Deposit
- A Share Portfolio.
I have excluded Bonds, as they are not as easily accessible. They can offer a guaranteed return, but you need to lock in for the period that the debt instrument is based upon.
An endowment is a 5-year period investment. It can be accessed before that time but will draw penalties if taken earlier. It does offer three advantages. Firstly, a little fact not widely known, it allows protection from creditors after 3 years. This includes the proceeds when taken out. The 2nd advantage compared to the other mentioned discretionary products, is that it allows for the nomination of a beneficiary. This again, takes this out of the estate as far as executors fees go. The last advantage is a tax one, but limited to only high-income earners. While it does pay out tax free, do not be fooled by this. It is taxed, but within the funds under the 5-fund approach. This means at company tax rate. So that rate would be lower than the rate your high-income earners will pay.
Bank products such as fixed deposits offer a guaranteed return, but then you lock yourself in for the selected term. The longer the term, the better the rate. Just bear in mind that under current circumstances, being July 2020, rates will be low. They will increase going forward. Another bank product will be a Money Market account. This may not offer as good a return as the fixed deposit, but it will provide accessibility. Just also bear in mind that this is not a place to put long term monies that must outperform inflation. The disadvantages are that it has no beneficiary and that earnings over a long-term will not be a great as other categories of discretionary investments that are outside of fixed interest.
A share portfolio can offer good returns over a long period but is not suited for short term needs. Accessibility is not a problem. But you may need to access when markets are down, locking in loss. Also, this is a product that also does not have a beneficiary and is not suited for smaller investment amounts. Reason being that the smaller the basket of shares, the higher the risk, as you lessen diversification. If you want the diversification, and have limited funds, invest in a Unit Trust rather.
Unit trusts are possibly the best suited product that ticks most boxes. Its accessible, cost effective and can give you the diversity, giving you exposure to the markets to have inflation beating returns over the long term, while not taking the flexibility and accessibility away on the short term. Just bear in mind that they do not offer guarantees as they are market related, especially those which are equity based or have equity as one of the asset classes it invests in. The disadvantage is that it also does not allow for a beneficiary, so on death it will form part of your estate and pay according to your last wishes in your will.
It can be used in a tax efficient way, by using the first R36K per tax year, into a Tax-Free Savings account Unit trust Platform. This means all proceeds and capital are totally tax free as long as its capped-on contributions not exceeding R36K per tax year and R500K per lifetime of the policy owner. Any contributions over that are taxed at the highest tax rate.
Unit trusts also offer you the ability to take or add lump sums or draw an income. During hard times like we are experiencing now; they can be used to supplement our income or to add for shortfalls in our businesses or households. Accessibility takes about a week from when you submit the withdrawal requirements.
The horse may have bolted from the stables now but let us learn from this and be efficient going forward. Plan for difficult times by building your savings as shown above. If there is spare cash lying around, now is a good time to also invest. Buy low not high.
Your best bet is also to chat to a financial advisor, who can help set up a financial plan for you. It should be tailor made to your circumstances. Budgets, liability, taxes, and marriage regimes are some of the factors that will drive you towards a particular product. These factors all have an influence on where you invest. If you do not have an advisor, please let us assist you.