Monthly Archives: April 2016
I am regularly asked for advice by younger people looking for a sure-fire way to build their wealth. They are often surprised when I tell them to invest more time and money in themselves and their human capital. Historically, people who do this are likely to create significantly more wealth over their lifetime than those who don’t. It is obvious that you need to accumulate investment assets but you also need to ensure that you earn income at an increasing rate over your career. The best way to do this is by investing in yourself.
What is human capital?
Human capital is the combination of skills, knowledge and abilities you have that will enable you to generate income over your working life. Nearly all of us have an ability to generate some income but very few people consistently invest in themselves so that they can increase their earning potential over time. According to the Federal Reserve of San Francisco, university graduates generate R16 million more income over their careers than non-graduates. This might give some context to the #feesmustfall campaign in South Africa.
If you choose to invest in yourself, you need to ensure that your skills and knowledge remain relevant and adaptable to changing economic conditions and an evolving business environment. You should regularly review whether you need to add to your skills or knowledge-base. Additionally, you need to be honest enough with yourself to be able to decide if you need to change careers if you are in a dead-end street. For instance, I would not consider newspaper printing as a long-term career option!
Specialise but not too much
Some careers reward those who specialise but one should always be careful of becoming too narrowly focused in your career. For example, deciding on an academic career researching the mating habits of albino penguins in the Southern Cape might not ensure a long-term income. However there might be less risk in being the orthopaedic surgeon who specialises in surgery of the shoulder in South Africa. Many young people strive to be a manager in a large corporate. This might be the most risky career choice one can make. Managers are essentially generalists and are often the first people to be fired in a merger or downsizing. If you plan to work in a corporate, you might do better focusing on being a revenue generator or product specialist.
Not only for academics
If you are not academically inclined or you have no interest in tech, you could always consider specialising in old world industries. There is a massive shortage of plumbers, electricians and general handymen. Now that more people work in services industries, there are many fewer people who can work with their hands. This provides an ideal opportunity for reskilling yourself if you have the inclination.
In the age of mass production and “mass specialisation” provided by the internet of things, it should not be surprising that there is a major shortage of people who can build or create objects with their hands. I believe craftsmen who can make handmade items such as furniture or master builders are in big demand. It does not surprise me that craft beer, artisanal baking and coffee are becoming major industries. More people are becoming interested in where their food and drinks are made and this includes where the ingredients are sourced. This is the type of trend that is likely to suit those with old world skills and when skills are limited and demand is increasing, your earning ability increases rapidly.
To answer all of your questions, let us first consider the tax treatment of rental income. Any rental income you receive should be added to any other taxable income you may have, and assessed in its entirety.
The taxable amount of rental income may, however, be reduced, as you may incur expenses during the period that the property was let. Only expenses incurred in the production of that rental income can be claimed. Any capital and/or private expenses won’t be allowed as a deduction.
Expenses that may be deducted from taxable income are your rates and taxes, interest on the bond, advertisements, fees paid to estate agents, homeowners insurance (not household contents), garden services, repairs in respect of the area let, and security and property levies.
It is important that maintenance and repairs should be noted as specific costs and not confused with improvement costs. Improvements are a capital expense and cannot be claimed as an expense. They can, however, be included in the base cost of the property to effectively reduce the capital gain (or loss) on the disposal of the property, for capital gains tax (CGT) purposes.
To answer your first question then, the municipal rates were paid as a lump sum amount of R30 000 in June 2015 on the sale of the house. Assuming that the property was still being let during the 2016 tax year that runs from March 2015 until February 2016, the seller would be able to deduct the full amount of R30 000 in the 2016 tax year.
On the second question, current legislation entitles individuals to disregard any capital gain on the disposal of their primary residence if the proceeds do not exceed R2 million. In such event the individual does not need to determine the base cost of the residence.
In order to claim this exclusion we need to determine what qualifies as a primary residence.
To meet the requirements, it must be a structure (including a boat, caravan or mobile home) which is used as a place of residence by an individual. An individual or special trust must own an interest in the residence. And the individual with an interest in the residence, beneficiary of the special trust, or spouse of that person or beneficiary must ordinarily reside in the home and use it mainly for domestic purposes as his or her ordinary residence.
The question in your case is what will happen to the CGT exclusion if you rent your residence out to a tenant for a period of time and then decide to sell the house?
A residence is treated as having been used for domestic purposes during any continuous period of absence, while the residence is being let under the following circumstances:
1) The residence must not be let for more than five years. You, your spouse or a beneficiary of a special trust must have resided in the residence for a continuous period of at least one year before and one year after the period of absence.
2) You treated no other residence as a primary residence during your absence.
3) You were temporarily absent from the Republic or employed or engaged in carrying on business in the Republic at a location further than 250km from the residence.
In this advice column, Zipho Mnyande from Alexander Forbes answers questions from a reader who wants to save up to buy a second car.
Q: I would like to start saving for a second motor vehicle. My current car is paid off and still in very good condition, so I don’t think I will need to replace it within the next five years.
I would therefore like to save the money that I was paying towards my monthly instalments to eventually buy a second motor vehicle for cash. Therefore, my savings term would be at least five years.
I have a money market fund with Allan Gray at the moment, but I find it difficult not to use these savings for other larger expenses. I would therefore prefer to use something that does not allow immediate and easy access to my savings. What would be best for this purpose?
The first step one should take is to identify the investment objective. In this case that is a car, with an assumed cost of R300 000 at the end of a five-year term horizon. It is important to understand this time horizon as well as your appetite for risk to decide on the most suitable investment vehicle.
Some of the most popular after-tax investment vehicles include endowments, unit trusts and the tax free savings accounts. These vary in terms of accessibility and tax implications and we would need to know the clients full financial situation before recommending a suitable product.
For a client who wants to lock their investment for a five-year period, an endowment would be a vehicle to consider. We do, however, have to take into account their marginal tax rate when making this decision.
This is because endowments are taxed within the fund at a set rate of 30%. This benefits investors who have a marginal tax rate greater than that, but can be prejudicial if their tax rate is lower.
Because the money in an endowment is taxed within the fund, your withdrawals are tax free. In order to get this benefit, however, endowments have a minimum investment time horizon of five years. At that point the money can be accessed or the investor can choose to extend the policy term.
You would be able to choose different underlying investments within the endowment, and given your time horizon, a moderate-to-balanced portfolio will most likely be appropriate. It is, however, important to take your risk appetite into account.
To know whether this would really be the best option for you, however, it is important to get an understanding of the tax implications from your financial advisor.
Zipho Mnyande is a financial consultant with Alexander Forbes Retail in Johannesburg.
As with many similar questions that I have been asked over the years, it is vital that you meet with a financial planner. A full understanding of your financial situation is required. It is not wise to give recommendations based on only a portion of your investment information.
However, that said, let’s assume that I have understood your risk profile accurately, and that a ‘couple of years’ refers to two years. I would consider the following to be wise counsel:
It is unlikely that allocating the full amount to gold would be appropriate as the price of gold can be volatile over short-term periods. I would also assume that the lump sum of R500 000 is unlikely to be a small portion (i.e. less than 5%) of your overall portfolio, and this makes it even less appropriate to allocate the full amount to gold.
In addition, you specifically ask about physical gold, which in most cases is Krugerrands. When investing in Krugerrands there are fees of about R3 000 per ounce (you can buy for R21 000 versus selling for R18 000 as per the Cape Gold Coin Exchange), which need to be taken into account. Over a short-term horizon, these costs could be really punitive.
The gold price would therefore have to increase substantially over your two year period to beat the 6.4% per annum offered by your money market option. Remember you will also have to take into account the storage and insurance costs of holding physical gold. Therefore, taking all things into consideration, I would consider gold to be a relatively high risk investment for you.
The money market is probably one of your safest options. However, I am interested that you quote an interest rate of 6.4%, as I know other options that offer up to 8.0% per annum. Make sure that you do your homework well, in conjunction with your financial planner. You may even look at the possibility of a 24 month fixed deposit, where the interest offered is currently about 8.8%.
Depending on your marginal tax rate and your age, a more efficient investment may well be through a dividend income-type of portfolio. Ask your financial planner about this because you should be able to achieve an improved growth rate after tax compared to a money market. All in all, this will still be the relatively low risk that you require in a two year, short-term investment.
The reader belongs to the Government Employees Pension Fund (GEPF), which is what is called a defined benefit fund. The retirement benefits are therefore defined with regard to the reader’s salary at retirement and the length of service at their employer.
Let us consider the two options that the reader has presented in more detail:
Receiving an annuity for life
The reader will receive an annuity, for life, which begins at R27 414 per month. On death, the spouse would continue to receive 50% of this annuity for the remainder of her life.
Pension increases are also usually granted annually by the GEPF in line with their policy which targets 100% of CPI. The reader is also entitled to a gratuity lump sum at retirement of R1.2 million.
Under this scenario, the GEPF, assumes the investment risk. In other words, the member will continue to receive their pension, irrespective of how the underlying investments perform.
The GEPF also assumes the longevity risk, or the risk of the member and their spouse living longer than expected. As an extreme example, if they both lived to 120 years, they will continue to receive their pension. On the other side of the coin though, if they both pass away shortly after retirement, no further payments will be made and any children dependants will not receive any lump sum payment.
Taking the lump sum and investing it
The reader states that they are entitled to R5 047 648 as a resignation benefit. For purposes of this comparison, the impact of tax on this amount has not been considered as this could vary by individual.
Let us assume that this money will be invested into a living annuity-type structure in order to provide a retirement pension. Under this scenario, the lump sum is invested and a pension is drawn from this balance for as long as the balance is positive.
To put it simply, this operates similar to a bank account. The account increases with investment returns and reduces by any amount that the reader withdraws in the form of a pension.
It is important to realise that the reader will be assuming both the investment and longevity risk under this scenario. Poor investment performance will impact on the amount of pension that the reader may be able to withdraw. Additionally, if the capital is fully eroded while the reader is alive, no further pension will be payable. However, on death, the balance of the account can be paid out to the spouse or other dependants.
Comparing the two
If we consider this reader’s particular circumstances, in order to match the R27 414 per month pension from the GEPF, they would need to draw 6.52% per annum from the living annuity balance.
For illustrative purposes, we assume that the account balance would grow at 10% per annum and that the reader would require the annual pension to increase in line with inflation at an assumed 6% per annum. Under these assumptions the investment growth on the account will exceed the pension being drawn for around nine years. After that the capital will start to be depleted and will be fully eroded after about 22 years.
Assuming that the reader is 60 years old, it is estimated that the capital will be fully eroded by age 82. If, on average, the account grows by less than 10% per annum, this amount will be eroded sooner. Thereafter, no pension will be available. This illustration demonstrates the investment and longevity risks the reader faces.
In essence, most pensioners, even those that are not members of the GEPF, are faced with a similar decision at retirement. They need to choose between investing in a guaranteed annuity which will be payable for life, or investing in a living annuity from which a pension can be drawn for as long as account has funds.
The choice of retirement vehicle is a complex one. The following is not an exhaustive list but includes some considerations that would need to be taken into account by anyone in this situation:
1) Attitude towards risk.
2) The level and nature of their base expenses in retirement.
3) Tax considerations of the various options.
4) Level of investment expertise and ability to obtain advice on choosing portfolios that will be able to generate sufficient returns.
5) Views about their health and longevity.
6) Bequest motives. The living annuity framework lends itself more easily to providing an inheritance to children on death, provided that there is a positive balance in the account. However, in this particular case, the reader will receive a gratuity of R1.2 million on retirement from the GEPF. Should they wish to leave an inheritance to their children, this amount could be invested and left to dependents on death.
Luthuli Capital was founded and structured as a Pan-African multi specialist company that offers a global approach to wealth management portfolios. The company offers investment advisory services to local and foreign individuals and multinationals, among others. I’m joined in the studio by one of the co-founders, Mduduzi Luthuli. Thank you so much for your time.
MDUDUZI LUTHULI: Thank you for the invitation. Glad to be here.
NASTASSIA ARENDSE: Let’s take it back to the beginning and start off with how Luthuli Capital came together.
MDUDUZI LUTHULI: I think if you are going to start a company it’s always something that’s there. It’s just a matter of acquiring the skills for you to be confident to run the company and wait for the circumstances to be there.
I’ve been in the corporate sector now – from banking into the financial advisory industry – for about seven years. My previous employer gave me a great opportunity in management and it’s really there where I got to cut my teeth and get to the point where I realised I think it’s time for me to go out there and do this on my own.
We’ve got two offices here in Sandton and one in Durban. It really was the Durban office that was also the big motivator because we’ve got a project going on down there which involves the internship, and that also just got to that point where, if ever you are going to do this, this is the time.
NASTASSIA ARENDSE: And I know that you work with Trudy as well. How did the two of you decide that it’s our synergies and both our characteristics and everything we’ve learned from our own sort of corporate size that can work together – and let’s do this?
MDUDUZI LUTHULI: We both come from the same industry. So from a product knowledge side, services, the competency was there. I think really where the synergy comes from is they say I’m the driving force, I’m the bully, I’m the hard-core one. My real talent is bringing the clients into the business, going out there and selling the dream and convincing them that this is something you should back.
And Trudy, as head of client services, is the mother of the business, if I can put it that way. And really her strength is in client retention. You play a fine balance between finding new clients and also looking after your existing clients. And that’s really where we work with each other’s strengths and work very well together, because she heads up the client retention. I bring them and she looks after them.