In a couple of months’ time, Tumi will be in a position to settle her car loan, which is currently costing her R2000 a month. Even though Tumi realises that this is probably the most expensive short-term debt on her expense list, she is quite keen to buy a new car that has more safety features.
After a bit of shopping around, she finally sets her heart on one of the latest trendy models that costs R150000. Various car dealers have also informed her that she can expect a trade-in value of R50000 on her current car.
Taking this into account and working on a 12,5% interest rate, let’s investigate all the options currently open to Tumi.
Option A: She could purchase the new car for R150000 that, after trade-in, would leave her with R100000 to pay off over five years.
However, assuming an interest rate of 12,5% she would have to pay about R2226 a month and, based on her risk profile, her monthly insurance premium would be about R313. In terms of this option, Tumi would clearly be paying a whole lot more than she is at the moment.
Option B: She could still opt to purchase the same car by reducing her instalments and deciding on a residual value of 15%. This means that her instalments would remain R2000, but after five years she would still be liable to pay an additional R15000 if she does not want to sell her car.
Since it is advisable to always insure your car to its full replacement value, her insurance premium would remain the same as in option A.
In this instance, her instalments might remain the same as what she is currently paying, but her insurance premium might be more than her present one.
Option C: She could consider exactly the same car, but a demo model that is 12 months old. Since cars depreciate by 25% in their first year, she would only pay R112500 for the same car. After her trade-in she would only need a loan of R62500 that would automatically reduce her instalments to R1390 a month. It is important to note that even though the car is approximately one year old, it is probably advisable to insure the vehicle to its full replacement value. She would be able to save nearly R300 with this option.
Option D: Her final option is to analyse whether she really needs a new car, as her current car is only five years old and not giving her any mechanical problems.
She could rather save R2000 a month and in a year or two she could have a much bigger deposit for a new car, further reducing her repayments.
How do the four options affect Tumi’s decisions?
An important aspect for Tumi to consider is how purchasing a new car will impact on her tax benefits.
For example, let’s assume that Tumi currently receives a travel allowance of R2000 a month and drives about 25000km a year, but does not use a logbook.
Since she is unable to submit proof of her kilometres travelled for business purposes by means of a logbook, her first 18000km travelled for the year will be deemed for private purposes, which means that she will only be able to claim against 7000km for business travel.
This indicates how her tax claims could differ between the various options (calculated claim for business travel to be deducted against allowance based on actual travel of 25000km):
Option A: R20093
Option B: R20093
Option C: R16325
Option D: R12566
(It is important to note that this is only for illustration purposes and that the real tax benefit can only be decided on assessment.)
Currently, 60% of the travel allowance (that is R1200 a month) will be subject to PAYE on a monthly basis. Only after Tumi can prove in her tax return that her business travel claim exceeded 40% of her travel allowance, will she receive a refund of income tax.
Alternatively, Tumi might have to pay income tax on assessment if her actual travel for the year is less than 25000km as in the current scenario.
The reason is that the monthly travel claim taken into account in calculating her PAYE would then exceed Tumi’s actual claim for business travel, and therefore the tax that was withheld during the year would be insufficient.
Another important fact for Tumi to remember is that last month she discovered that she required an additional R2Â 000 a month to make up for a shortfall on her retirement savings.
With options C and D, Tumi is now in a better position to increase her retirement savings.
Then again, option C allows Tumi to purchase the car she so badly wants; yet at the same time she is also able to contribute an additional savings of R300 a month towards retirement savings.
She could opt to invest in a unit trust such as a balanced-typed fund, which is a moderate risk fund that complies with Regulation 28 of the Pension Funds Act.
As an example, let’s look at a fund like the Sanlam Balanced Fund. Over a five-year period (that is 2001 to 2006) and based on a R300 saving a month, Tumi could have saved about R36Â 000 towards retirement savings, basically doubling her savings.
Finally, Tumi must remember that these figures are merely for illustration purposes and that any decisions regarding retirement planning, investment advice, tax consulting and similar issues, must be made together with a financial specialist.
Tumi must also ensure that her car loan is aligned with her future financial needs and that advice from a financial planner could benefit her in the long run, since her financial circumstances will be holistically evaluated.