A late starter’s guide to catching up on retirement savings

Question: My father is in his 50s with no retirement savings whatsoever. He wants to retire in 10 years.

I know he has left it a bit late and that he will probably not have a decent ­pension.

What is the best vehicle for him to use to make up some of the lost ground?

Answer: When we retire, we need to budget for living on our retirement savings for the next 35 years. As your father will only be investing for 10 years to provide for a 35-year retirement, it will be a challenge to provide him with a viable pension. We therefore need to plan carefully to get the best possible returns on his investments.

When it comes to choosing a vehicle for retirement, you need to consider income tax while you are investing, as well as the loss of income to tax when you have retired.

You are allowed to invest 27.5% of your taxable income in a retirement saving vehicle. This investment amount will be deducted from your taxable income and will result in a significant tax break, allowing you to invest even more into your retirement savings.

For example, if your marginal tax rate is 40%, an investment of R100,000 will cost you R60,000 once you take the tax deduction into account. 

To put it differently, an investment of R60,000 will give you a retirement annuity worth R100,000. This works out to an immediate return of 66%. This is a great way for your father to rapidly increase the size of his retirement investment.

Your father is probably in his maximum earning years and paying his highest level of tax. I would certainly recommend that he considers using the tax deductions that are provided by a retirement annuity.

The downside is that two-thirds of the investment must be used to purchase an annuity. This annuity will be taxed as income when you are on pension. You are, however, allowed to take a third of the investment as a lump sum, of which the first R550,000 is tax-free.

I would recommend that your father does this and reinvests the lump sum into a discretionary investment where the only tax he would pay would be capital gains tax.

The capital gains tax rate is 40% of your normal tax rate. You pay tax only on the gains that you have realised when drawing down your income. This can result in paying very little tax on the income.

Once your father has exhausted the 27.5% contributions to his retirement fund each year, he should invest R36,000 in a tax-free investment. The advantage is that he will not pay any capital gains tax on it when he makes drawdowns from it when he retires.

I would recommend that, for at least the next five years, your father invests in the most aggressive portfolios that he feels comfortable with. I would suggest that he consult a financial adviser who can help to optimise the portfolio selection.

Your father has left things a little late, but if he starts now and invests wisely, he can certainly improve his situation. DM

Kenny Meiring is an independent financial adviser. Contact him on 082 856 0348 or at financialwellnesscoach.co.za. Send your questions to [email protected]

This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R29.