Whilst many investors consider the most ominous threats to their retirement savings to be unpredictable market forces and failing economies, the truth is that some of the greatest threats to one’s retirement can be latent and unassuming. Even the most bullet-proof retirement plan can be disrupted by seemingly innocuous reasons, and it’s worth exploring some softer, more personal choices that can blind-side one’s retirement dreams.
Although most couples in their 40s and 50s probably don’t anticipate divorce, the numbers are somewhat unnerving. Regardless of the scale of a couple’s wealth or the amiability of the separation, a divorce can have catastrophic effects on one’s retirement planning; and any couple would be naive to believe they can unravel their marriage without severely compromising their retirement plans in the process. A divorce later on in life is bound to not only disrupt one’s financial independence, but also force a number of lifestyle changes to be made by both parties. What was once a jointly conceived retirement plan comprising of a single retirement home, joint overseas travel, appropriately timed vehicle upgrades and a retirement income sufficient to support a combined lifestyle would need to be cast aside and recalculated for each individual. Other than in a case of substantial wealth, both parties need to be prepared to compromise on lifestyle.
Although a divorce at any stage can create a financial set-back, divorces later in life are particularly problematic for one’s retirement funding. When a couple separates, it goes without saying that living expenses increase and wealth-building is compromised as a result of legal and associated fees. Divorcing later in life means that one has less time leading up to retirement in which to make up for any retirement shortfall that exists after the estate has been divided.
According to the 2014 Stats SA Marriages and Divorces report, most couples that are divorced have been married for between five and nine years. The average age of divorce was 43 for men and about 40 for women. Most people whose marriages ended in divorce had children under the age of 18, making it a particularly difficult time for any divorcee to start putting away extra money for retirement while also dealing with the increased costs associated with running a single-income household.
It is inevitable that the immediate financial burden of a divorce is felt on the separation of the household. Upon separating, a couple tends to double-up on expenses such as rent/home loan, rates, water, electricity, landline and non-consumables. Downscaling to more cost-effective accommodation is highly advisable post-divorce, despite one’s natural tendency to retain the family home for stability and emotional reasons. Purchasing or renting more affordable accommodation will allow one extra breathing room while still trying to cover the legal costs of the divorce, meeting maintenance and alimony requirements and attempting to recalibrate your retirement funding.
When negotiating a divorce, it is prudent to assess the nature of the assets that you will acquire in terms of the divorce settlement. Although the asset split is deemed to be equal in value, it is important to ensure that one is not left with illiquid assets that can cause cashflow problems later on. For example, where one spouse keeps his retirement annuity valued at R 1 million, and the other is awarded money market funds of R1 million, it is important to bear in mind that the first spouse will not be able to access the funds in the RA until age 55. There are also different tax and CGT implications attached to different types of assets which can affect the net value of the asset, and it is best to seek professional financial advice before agreeing on an asset split.
A contested divorce can cost anything from R10 000 to R500 000 if the court action drags on, whereas an uncontested divorce can cost as little as R4 000 depending on complexity. Legal fees in a divorce add up very quickly and can erode the net value of each partner’s estate. If your divorce is uncontested, we still advise that you seek legal and financial advice on the division of assets to ensure that you have a full understanding of what you are agreeing to. Before heading to the courts in a contested divorce, our advice is to first seek a mediated divorce, with the costs of a mediated divorce estimated to be about 70% lower than a protracted, litigated divorce.
- A second home (holiday home)
Buying a second home while both spouses are still working may often seem both affordable and practical, especially if the bond on the primary residence has been settled. While one’s children are at school, a second home is often the family’s holiday hub and a vacation bastion for friends and extended family. The thrill of owning a second home is, however, often replaced by anxiety once the reality of funding a second home from a reduced retirement income sets in. Added to the financial pressure of financing the second home, the upkeep of the second property often becomes an arduous duty rather than one of retirement’s anticipated pleasures. In addition, if the equity in the second home is needed to supplement other retirement investments, the timing of the sale of a second home can be instrumental to secure one’s retirement cashflow. Being forced to sell a second property at an inopportune time can result in your nest egg being compromised. The timing of a future sale, together with the emotional consequences of selling the family’s holiday home, are factors that need to be taken into account at the outset. It is also important to bear in mind that, if the holiday house was purchase after October 2001, you would be liable to pay Capital Gains Tax to the extent at which the value of the property has increased since date of purchase. When factoring in the proceeds of the second property into your retirement plan, it is important to factor in CGT, agent’s commissions and other costs before arriving at the net proceeds you would have available to invest.
- Your choice of retirement home
Deciding on the right retirement accommodation can be a daunting task, and it is way more complicated than simply downscaling one’s primary residence. Health, age and affordability are obvious factors that need to be taken into account when choosing a retirement home. In addition, proximity to medical facilities, family and broader support system are important considerations. Loneliness and boredom, specifically in the case of a single retiree, are factors that need to be considered and can make the idea of a retirement village a hugely attractive one. Although maintaining one’s home may seem manageable at age 65, it can become an overwhelming and expensive task as one ages. Personal security and the need for assisted living are also factors that should be considered when deciding to stay in one’s own home during retirement.
Other than staying in one’s own home, the main purchase options available to retirees include Sectional Title, Share Block Schemes and Life Rights, and it is imperative to consider the financial implications of each transaction when putting one’s financial plan together. Each option should be carefully considered in respect of retirement income, lifestyle goals and affordability. Because each facility comes with its own unique offering in respect of domestic services, garden services, frail care, assisted living and private nursing, it is almost impossible to compare apples with apples. Before committing to any of these purchase schemes, our advice is to compare a number of developments in terms of the services, facilities and costs. Specifically, ensure that you understand exactly what services and facilities you are buying, and what additional levies and costs you will liable for in the future.
- Financial support to adult children
One of the single biggest threats to a couple’s retirement funding is adult children who continually ask to borrow money from their parent’s nest egg. Helping one’s adult children with the purchase of their first property or assisting them financially when embarking on a new business venture are both notable and natural acts of any parent anxious to give their child a stronger financial footing. The problem, however, arises when financial assistance happens so often that it becomes a form of annuity income for the adult child who, in most instances, is completely oblivious to his parent’s dwindling resources. Financially dependent adult children present two major complexities: the parents are often too wracked with guilt to withdraw the funding from their child, who will naturally suffer the consequences of the taps being turned off; and the adult child, being both emotionally and financially dependent on this parents, makes the dangerous assumption that his parents keep lending him money because they have a surplus of funds.
It is common knowledge that Millennials are heavily burdened by student debt, and that this debt can delay their transition to financial independence. Some reports indicate that has many as one third of 30-somethings receive substantial and ongoing financial support from their parents. Interestingly enough, it appears that most parents agree that it is harder for young adults to live within their means that it was for them at the same age. From a financial planning perspective, our experience shows that adult children’s finances weighs heavily on the minds of our older clients and often keeps them awake at night. Many older clients admit to staying in the workforce or needing to work longer because their adult children are draining their retirement funding.
Many older clients are torn between helping their adult children financially now as opposed to leaving them a larger inheritance later, with many clients choosing the latter in the hopes that their children will become successful and independent in their own right. However, parents who have worked hard for their financial freedom and are financially able to do so would naturally want to help their adult children while they are still alive. To reduce the risk of dependency whilst at the same time having the pleasure of spoiling one’s adult children, it is advisable to not take responsibility for any recurring expenses belong to one’s adult child so as to ensure that they are able to meet their everyday expenses and allow your financial gifts to be over and above these costs. Many parents choose to help their adult children with the purchase of their first car, the set-up costs of new digs or the cost of a family vacation. These are great ways to assist one’s adult children without committing to ongoing financial support.
- Longevity and medical enhancements
As much as medical enhancements have extended average human longevity, a knock-on effect is that people are spending more time living with often debilitating conditions and/or disabilities. The Global Burden of Disease study published in The Lancet gathered data in 195 countries and territories between 1990 and 2015. Their research showed that people are now living longer lives, but much more of their lives are spent living with ill health as a result of medical enhancements.
According to a report in the UK Independent in October 2016, medical professionals believe that more and more time is being spent prolonging life at the expense of the quality of life that people enjoy in their final years. Although there are significant societal advantages to having an aging population, such as grandchildren having greater access to their grandparents and the experience of grandparents can be passed on to younger generations, there are financial implications to living longer that can burden one’s retirement plan.
As a result of medical improvements, age-related chronic diseases such as heart disease, certain cancers and diabetes have risen, and illnesses such as Dementia and Alzheimer’s are expected to double every twenty years. A person can now live many years whilst suffering from any of these illnesses, but at a price. Specialised doctors, frail care, nursing homes and assisted living centres are hugely expensive and not widely available in the more remote areas of South Africa.
According to Discovery CEO, Adrian Gore, as you live longer, your life expectancy grows. “So, for example, if you reach age 65, your life expectancy goes up to 82 or 84. If you live to 85, your life expectancy goes up to 91”, he says. “Discovery statistics show that if you are 40 years old, you are likely to spend 42% of your life in retirement. If you are 35, 38% of your future will be in retirement years.”
From a financial planning perspective, we always work towards a life expectancy of age 100 of the younger spouse or partner as one of the greatest risks to a retirement plan is that the client outlives his capital.
- Starting a business
Retired executives with an entrepreneurial itch often find the temptation to start a business irresistible, but doing so can dig dangerously into much-needed retirement capital. As enticing as it may be to dabble in an exciting new business venture or try one’s hand at innovation, the truth is that very few earn what they would have earned if they’d simply kept their funds invested. It would be wiser to consider alternative outlets to channel one’s entrepreneurial energies rather than disinvesting one’s lifetime assets in the hopes of satisfying an entrepreneurial whim. However, the trend is firmly underway, and more and more baby boomers are ‘re-wiring’ after retiring by moving into the consultancy space, purchasing a franchise, starting a small business or entering into a joint venture with a friend or family member. Some even start investing in property in the hopes of building a rental property portfolio.
Financially, emotionally and physically, working beyond the formal retirement age of 65 is highly advisable as it keeps a person engaged with society, adds purpose and fulfilment to their day, and allows one to contribute meaningfully to the economy. Our advice, however, is to ensure that you do not access your retirement capital to fund your business start-up. The capital needed to fund one’s retirement, allowing for an extended life expectancy, inflationary increases and increased medical expenses (which generally outstrip inflation by around 4%), should be ring-fenced and secured. One of the biggest threats to any new business is not having sufficient capital to carry on when the new business faces a snare, and the temptation to dip into retirement capital can be great, but should be avoided at all costs.
If you do have plans to start your own business after formal retirement, our advice is to start setting funds away for this specific purpose. These funds should be invested in a strategy that is commensurate with your investment horizon. For instance, if you are planning to retire within the next five years, it would be unwise to invest in a high risk strategy as this could result in you not having sufficient funds available when needed as a result of short-term market fluctuations. These funds should specifically be earmarked for your business venture, and should be supported by a sound business plan.
- Giving away too much, too soon
One of the greatest joys of financial freedom is the ability to pursue one’s philanthropic pleasures, and this is true for many retirees who have a heart for a specific charity or cause. However, there is a danger of over-estimating how much one can dispose of by way of donations and charitable giving during one’s life-time, and leaving a shortfall in your retirement capital. Careful planning with a financial planner who has a in-depth understanding of South Africa’s Donations Tax legislation is essential before making any decisions to give away assets while still alive. Further, one’s financial planner needs to ensure that your retirement plan is resilient enough to withstand the intended donation, leaving room for variation in the underlying assumptions used when developing the plan, such as life expectancy, inflationary increases, medical costs and large unforeseen expenses. Our advice is to err on the side of caution and work your legacy into your Last Will and Testament rather than seek to give too many of your assets away while still alive.
- Investing too conservatively
Many investors who are risk-averse by nature tend to invest too conservatively for retirement, despite the fact that they have a long time horizon in which to achieve their goals. Investing too conservatively can have detrimental effects in your investment’s long-term ability to achieve the returns needed to support your desired retirement lifestyle. If a person began invested with their first pay cheque at, for instance, age 25, they would effectively have a forty-year investment timeline. Although stock markets experience enormous short term volatility, they have proven to be resilient over the long-term.
We have had experience with clients who, with almost ten years before retirement, are too nervous to move their money out of money market and into a unit trust portfolio out of fear. They are more comfortable achieving money market returns than using the stock markets to achieve more favourable returns. Many clients face what we refer to as ‘analysis-paralysis’ when it comes to investing, and often end up doing nothing at the expense of their returns. Their inability to make decisions is compounded by over-thinking issues such as market timing, when and how to enter the markets, and how tracking market performance on a daily basis – none of which really matters when you are investing for the long-term.
It is important to bear in mind that investing too aggressively in relation to your personal propensity for risk can be counter-productive and can result in you experiencing unnecessary stress and anxiety over an investment that really should not be top-of-mind if it is invested for the long-term. Our advice is to choose an investment strategy that achieves a balance between your desired investment returns, your personal tolerance for risk, the tax deductions legally available to you and your investment horizon. Appointing an expert multi-manager to your funds entails giving a clear investment mandate to a professional investment company to invest your funds on your behalf, whilst taking into account the optimal balance you wish to achieve. Your appointed multi-manager will track and manage your funds on a daily basis (so that you don’t have to) in accordance with your specific mandate with the assurance that your investment falls within your area of comfort in respect of both risk and returns.
- Retirement scams
The two most destructive emotions when it comes to investing are greed and fear, and investment scammers use this to their advantage. Among the most common scams used are Ponzi and pyramid schemes, as well as “advance-fee” or “419” scams. Operators of these schemes prey on retirees who are fearful that they don’t have enough money saved for retirement, or anxious to earn greater returns than their investments are currently achieving. Fin24 recently reported that the South African Reserve Bank launched a national campaign called ‘Easy come, easy go’ to raise awareness of these scams which include, Ponzi, pyramid and 419 scams. These schemes promise victims large amounts of money, but ‘investors’ are required to make upfront payments first. In fact, in 2015, SARB was investigating 41 illegal deposit-taking schemes, and over 5 000 advance-fee scams have been reported to SARB in the past five years.
Our advice is to use extreme caution when approaching investment opportunities and apply common sense. Any investment fund you consider investing in must be registered with the Financial Services Board or their local equivalent as an authorised financial services provider, so this would be your first check. Be cautious of any business that does not have a registered physical address or website presence, or that has contact details that include Gmail, Hotmail or Yahoo accounts, with no physical address or website presence. Be suspicious of any investment opportunity where you are being aggressively pursued to participate. Complex commission and incentive structures are a trade-mark of investment scams. If you don’t understand the business model, walk away. Never invest in something you don’t understand. If you’re unsure, rather seek professional advice from a Certified Financial Planning® professional.
- Myth of spending less in retirement
Many financial experts agree that, as a general rule, one would need between 70% and 80% of one’s pre-retirement income to live comfortably in retirement. This ball-park figure is based on the assumption that one’s debt would be settled by retirement. However, there are a number of factors that can cause one’s monthly post-retirement expenditure to exceed this benchmark, and flexibility needs to be built into one’s retirement plan to ensure that there is room to move.
Rising medical costs: Most retirement plans allow for living expenses to increase annually in line with inflation and do not account for the fact that medical inflation outstrips CPI year-on-year by about 4%. We are living longer with chronic illnesses that are being treated at a high cost, and we need to account for these costs in our planning. Living longer with debilitating illnesses means that we need to factor in the cost of frail care, assisted living and nursing homes, which come at a high price.
The CPIX, the basic measure of inflation of all goods in South Africa (excluding mortgage bonds) has been almost exactly 6% over the last five years. According to Adrian Gore of Discovery, during the same period the drivers of medical inflation looked like this:
– Private hospitals: 13%
– Specialists: 9%
– Prescription medication: 9%
– GPs and allied services: 5%
– Medical aid administration fees 4.8%
You will notice that private hospitals, specialists and prescribed medicines – all of which are essential medical services for the aged – are the key drivers of medical inflation and outstrip normal inflation by between 3% and 7%, and one’s retirement plan needs to be fortified against these increases.
Inflationary increases: South Africa is undergoing political and economic turmoil at present, and our recent downgrade to junk status could have an effect on inflation over the medium term. Our advice is to ensure that there is fat built into your retirement plan that allows for a higher rate of inflation.
Home maintenance: The decision to stay in one’s home or downgrade to a smaller home could result in higher maintenance costs, especially as the property ages. As one becomes older and less mobile, it would in all likelihood be necessary to outsource the maintenance and general upkeep, and these costs could add-up.
Electricity costs: Electricity prices in South Africa have increased by over 300% since 2004, and this trend is likely to continue, with some estimating that increases will continue to be between 15% and 25%.
As investors, we are often so focused on the obvious threats to our investments that we neglect to take cognisance of the not-so-obvious dangers that we may encounter on the path to building wealth. Even the best-laid retirement plans are capable of being derailed by seemingly innocuous decisions, giving truth to the words of George R. R. Martin in A Clash of Kings, “the unseen enemy is always the most fearsome.”
Have a wonderful Tuesday.
Categories: Financial Planning