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Wednesday, 4 April 2018

A Retirement Plan No One Will Tell You About

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Stealthy Junior's latest creation 
For those of you who do not know what a TFSA is, it is basically Government’s way of giving you money encouraging people to save and invest. Everything you put into a Tax Free Savings Account is…well….tax free (can’t imagine how they came up with the name…)

So you won’t pay any Capital Gains Tax, and you wont be taxed on any interest, income or dividends. In short TFSA’s are pretty awesome.

However, there are a few rules. You are not allowed to put more than R33 000 a year into your TFSA, and you are not allowed to contribute more than R500 000 in your lifetime. These values will hopefully be increased over time, which would be great, but for now these are the limits. If you contribute the maximum amount per year, which is R33 000, it means you will be putting in R2 750 a month. At this rate you will reach your lifetime limit in 15 years and 2 months.

So, if you were able to cut out some expenses and free up R2750 a month, what kind of future investment value could you be looking at, and would it be enough to retire on?

Since a TFSA should be a long term investment, I am going to assume a 100% equity allocation, which, historically over the long term would have returned a little over 15% (I have previously got some flack for using this value which many feel is too high – but just remember that whenever you see article's quoting long term performance figures, keep in mind that most of the time they are forgetting dividends). So, for now, let’s assume an annual return of 15%.

Using this, I calculate that after the 15 and a bit years of making a R2750 monthly contribution to a TFSA, you will have a nice little nest egg worth just over R1.7 Million.

However this is R1.7 Million is “future money” and we need to account for inflation (historically this has been around 6% p.a.). After making the adjustment, I calculated you will have around R726 000 in today’s money.

Tax free.

Not too shabby!

The above calculation is for the case where you contributed your lifetime limit and then immediately stopped and cashed out. However all the youngsters out there are in an extremely fortunate situation with a lot of time on their side.

Let’s take the case of a 21 year old, fresh out of University/College with a bad attitude the world at their feet. Let’s assume they make a R2750 monthly contribution to their TFSA until they reach the lifetime contribution limit, and then leave that investment untouched until they are 55 years old. With this extra time, the power of compound interest really kicks in.

At age 55 this person will have a very tidy R3.3 Million in today’s money! And Tax Free! (Using the 4% Rule, that would be enough to draw an income of R11 000 a month).



Now let’s assume that this person found their soul mate - immediately obvious by the fact that they too had started contributing to their TFSA at age 21. If we combine their TFSA values at age 55, they would have R6.6 Million. If they followed the 4% Rule that would allow them to draw an income of R22 000 a month – inflation adjusted until the day they die. And remember - tax free!

While they are not going to be jet setting across the world in a private jet, R22 000 a month is probably enough for a modest to comfortable retirement. And in light of the dismal retirement stats in South Africa, R22 000 a month would be something most retired couples would accept with open arms!

But for those who are still not convinced, let's run the scenario a little longer. Instead of stopping at age 55, let's assume they each continued working for another 5 years, and then retired at age 60. This is what they would each end up with (inflation adjusted):


The couple's combined TFSA balances would be worth more than R10 Million in today's money! That would be enough for a monthly tax free income of R33 000 a month - and I think you would have a tough time arguing that that is not enough?

Isn’t that amazing – despite only investing for a little over 15 of their 39 year working careers, a couple maxing out their TFSA’s from an early age, and without any contributions to anything else (RA’s, company pension plans, discretionary investments etc.) would have more than enough for retirement!

So a pretty solid retirement plan (and one which no financial adviser would tell you about) would be:
  1. Age 21-36: Contribute R2750/month to a TFSA 
  2. Marry someone doing the same 
  3. Age 36-60: No more investing, blow all your cash on cars, houses & travelling 
  4. Age 60: Retire with more than enough (> R10 Million)
I guess the key takeaways from all of this (and you have heard these many times before, but definitely worth mentioning again):
  1. Start early
  2. Don't cash out money earmarked for retirement
  3. Ignore all the media noise, talking heads, perennial pessimists and continuous warnings of impending doom.
Ah.... to be 21 again....

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*I suspect I will still get some flack for using an annual return of 15%. So for the more conservative people, I reran the numbers using a return of 12% per annum, inflation adjusting the final investment amount, and using the 4% Rule to estimate retirement income. The results for someone starting at age 21 are still pretty decent:

- After maxing out a TFSA (15 years, and 2 months) - TFSA Balance ~R600 000
- At Age 55 - TFSA Balance ~ R2 Million (or R4 Million for a couple = R13 000/month in retirement)
- At Age 60 - TFSA Balance ~ R2.77 Million (or R5.54 Million for a couple = R18 400/month in retirement)





Till next time, Stay Stealthy!
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