The disadvantage of investing in stocks is that the stock market does not provide a predictable return. Photo: File
I am constantly told that having my pension invested in a fixed deposit at the bank is a big mistake. Those who tell me this say they are invested in stock portfolios and claim they don’t pay tax. I realize that the amount invested determines the tax payable, but I would like to know if people who have entrusted their finances to investment managers are better off.
RESPONSES FROM THE MUNICIPAL PRESS:
There are several reasons why it’s not ideal to have all of your pension money in cash in the bank:
. The interest you receive from a fixed deposit will not keep up with inflation. This means that you are getting poorer each year because the interest you earn will buy less each year as the price of goods and services rises.
. Stock market investments have beaten cash over time. For example, over the past 10 years, the average return for a balanced fund (this is an investment where a pension would typically be found) was 11% per year. After accounting for inflation, this means the investment delivered 5.6% above inflation.
. Interest is taxed as income. If you are under 65, the first R23,800 of interest is exempt from tax, but is then added to your taxable income. From the age of 65, you can earn R34,500 a year in tax-free interest before it is added to your taxable income.
. Dividends you earn on your equity investments are paid to you after tax. This means that the company issuing the dividends pays the tax (currently 20%), so it does not affect your tax rate or increase the amount of tax you pay. Maybe that’s what your friends do if they say they don’t pay tax.
If you sell shares in your investment then there is capital gains tax, but you do not pay capital gains tax on the first R40,000 of capital gain. The amount of capital gains tax you pay is based on your tax rate. However, the maximum capital gains tax one would pay is 18%.
It depends on your tax rate, but it may be more tax efficient to earn income from dividends and capital gains (again, an investment). The disadvantage of investing in stocks is that the stock market does not provide a predictable return.
Unlike a fixed deposit where you know exactly how much money you will be paid, the stock market can go up and down in the short term. Although over time it outperforms cash, you need to make sure your investment is structured to handle short term losses.
It is best to seek advice before investing your pension in a market-linked fund. A good financial planner can make a huge difference to your results in retirement. a bad one will only cost you money.
It is important to find the right person to provide advice. A good place to start is to find a financial planner that charges fees, not commissions.
. Visit the Financial Planner Institute website at fpi.co.za to find a Certified Financial Planner