Spoiler alert: to make your money grow you have to invest it. Short of taking a massive risk and betting your salary at a casino to try to double your money, there is no quick or easy fix to create wealth. If you are prepared to be patient, however, there are ways to get there without taking huge, unnecessary risks.
If you were to bank your salary and keep what was left over at the end of every month, you would accumulate capital, but that capital would not grow on its own. Considering that inflationary costs of consumer goods and services eat away at the spending power of our earnings by about 5% each year, the buying power of that accumulated cash would be diminished over time, making your nest egg worth less each year!
The smart way to beat inflation is to invest these savings in products that are designed to grow capital without taking undue risk and attracting unnecessary fees. If risk can be managed appropriately and fees are kept low enough, your capital should grow faster than the rate of inflation, this increases your spending power over time.
Marietta du Preez, General Manager at Ecsponent Financial Services says, “One of the best ways to beat inflation is to use what can effectively be seen as annual gifts for this purpose: bonuses and tax refunds. If you’ve already parted with the tax you’ve paid during a year, and you’ve made it to the end of the year, the best thing to do is to consider that money already “gone” and invest your tax refund as a freebie.”
The “how” is quite easy: a retirement annuity is designed to take advantage of government incentives that promote saving for retirement. South Africa does not have an adequate social security structure, which means that we have to take care of our own retirement savings. This is why the government has set up incentives for various products that will eliminate or minimise taxes when used for retirement savings.
“The first and most well-known vehicle is the retirement annuity, commonly known as an RA. Contributing up to 27.5% of your annual income to a retirement annuity (up to a maximum of R350 000) can be done tax-free. This means that the whole R350 000 can start earning for you, without paying a cent of tax,” says du Preez.
The effect of compounding over time is immensely important and explains why it is better to try to put away as much money as possible. If a person at 40 years of age receives a tax refund of R30 000, for example, that person will have approximately 20 years to typical retirement age, and can grow that single invested lump sum to around R80 000 through compounded annual growth of 10% for 20 years. The costs associated with a typical RA investment are taken into account.
An alternative is to use a tax-free savings account, or TFSA, which differs from a regular bank account. Essentially, it is another type of collective investment where your capital is invested on your behalf, but significantly reduces the taxes involved in getting into, and out of, such an investment to help you grow your capital. There is no tax on dividends from a TFSA, and it will not be subject to capital gains.
TFSAs are offered by most financial institutions and vary in type, but they all come with the same benefits: South Africans can invest up to R30 000 per year, or R2 500 per month, in a TFSA, with a lifetime maximum of up to R500 000, which can then keep growing and compounding without attracting taxes.
Using a TFSA can significantly boost your retirement nest egg, and can help prevent an all-too-typical situation where people are forced to defer retirement for years because they simply cannot afford to stop working. People live longer these days, so retiring at the age of 60 can mean trying to cover decades with saved capital. Medical costs also rise exponentially as you age.
“It pays, literally, to make smart decisions about investing before retirement, so that we don’t outlive our savings,” concludes du Preez.