Francois asks whether it is better to try to pay off his home loan as quickly as possible or start a retirement annuity (RA): I am 26 years old and earn a good salary. I am currently putting about 15% to 20% of my salary into my home loan. Should I rather invest this in an RA?
Maya replies: This highlights the importance of a holistic approach to your personal finances. The danger of putting all your savings into your home is that although you will have a roof over your head, you will not have any savings to pay you an income on retirement. You need to follow a holistic approach that both reduces your debt and builds up growth assets.
Home loan
As a general rule, a person should increase their monthly mortgage repayments by 10%. This ensures that you pay off your home faster, saving significant interest (you could pay it off within 15 years rather than 20 years), and should interest rates increase, you will be able to absorb the higher monthly payments.
Investments and insurance
- You then need to look at your financial needs to determine how to invest the remaining portion:
Retirement annuity: An RA can be a good option because of the tax benefit. Depending on your tax rate, the Receive of Revenue could fund up to 40% of your contributions and there is also no capital gains tax or tax on interest income. However, you need to check costs and flexibility. Fortunately, due to consumer pressure, so-called new-age retirement annuities are now available that are more cost effective and do not penalise you if you stop contributing. Some of these include RAs offered by asset management houses like Coronation, for example, which has no upfront fees and relatively low annual fees. If you are already contributing to a company pension fund the amount that you can invest into an RA may be limited from a tax point of view, so crunch the numbers first.
- Risk cover: At this age your biggest risk is not being able to work. An interesting fact — you are four times more likely to suffer from critical illness or be temporarily disabled than to die before the age of 65. Make sure you have adequate disability and critical illness cover.
- Emergency savings: Financial gurus recommend that you put 5% of your salary away for emergencies. This can range from your car breaking down to losing your job. This should be invested in a low-risk fund like a money market.
- Discretionary investments: These do not form part of your retirement planning and would be invested in products like unit trusts or a share portfolio. This fund could be for medium-term goals (five to 10 years) or as a semi-retirement fund. Many people today tend to change careers in their 50s, often going on their own. This would create a nest egg to give you choices later in life.
It is worth sitting down with a good financial adviser, especially at a relatively young age, to create a financial plan that optimises your savings. Once you start a family and have other financial obligations it becomes increasingly difficult to save.