I started this post with the intention of explaining why an RA isn’t for me. I’ve been skeptical for a while now that it’s advantages outweigh the constraints for disciplined investor. So, I built a model to prove my point. Only it didn’t. It didn’t disprove it either. In short, it depends.
This post is not for someone looking for a simple plan.
There are some brilliant reasons to have an RA, such as disciplined and structured savings, a deferred tax wrapper, protection from others (can’t be claimed in bankruptcy) and yourself (limited to drawing down when you are over 55).
But, I assume you are reading this to challenge some of your thinking.
I moved back from the UK to a land filled with opportunity and potential, albeit some of it latent. I still have a pension set up in the UK, which has far fewer restrictions than those of Reg 28. Reg 28 is meant to smooth performance by sacrificing some return, but until I am drawing down, I don’t care about volatility.
I personally think Reg 28 should be revised to closer match life-stage strategy funds. Besides as I am targeting FIRE (Financial Independence Retire Early), only be able to access the wealth when I’m 55 does not fit in with my plan.
I think that everyone should always start by building a similar foundation on the Personal Finance Journey.
- Emergency Fund – 3-6 months of expenses liquid
- TFSA – Max every year
- RA – 10%-20% of salary
Having those in place, reduces finance anxiety and stress.
Simplicity is often key, as we don’t inherently have the discipline and focus for something complex, we end up doing nothing.
This post is for those on a FIRE journey, those with a savings/investment rate well in excess of the 20%. It is for those who are interested in the RA vs. Offshore Equities (Or any asset class, if you tweak the model).
So, I built a model. Tax tables and all.
I am not a tax expert and this was a completely academic exercise. I do have a lot of experience creating financial models. Of course the creator is also aware of the limitations.
I’ve made some pretty significant assumptions, such as:
- Tax rates don’t change.
- I’ve ignored inflation or rather assumed a inflation adjusted return.
- I’ve ignored volatility in return – I’ve assumed FIRE’ees can time their exit, in a way timing the market.
- I’ve ignored currency volatility as the risk is usually priced in to some extent.
- I’ve ignored re-balancing between asset classes – which has been shown to enhance return as it scaffolds in sell high, buy low.
- I’ve assumed income stays flat – lifestyle tends to adjust accordingly (Parkinson’s Law – second interpretation).
- I’ve ignored dividend leakage and rather lowered the return expectation.
- I’ve ignored RA Maximums.
- Ignored Tax Free amounts.
The amount of assumptions and starting points should give you a hint to the limitations of a model.
Building the Model
Starting Parts – Can be changed
- CGT is taxed at 1/3 of Income Tax and I’ve assumed it’s the Satrix MSCI World (Although I actually go USD into a Vanguard fund)
- Future Draw Down rate of 5% (I personally think the 4% rule is too high, provided you are flexible) – it can easily be changed though in the model
- I’ve based the RA portfolio on the Sygnia Skeleton Fund as potentially the most attractive option
- Although I’ve said offshore – I’ve started with Satrix MSCI World – Which is Rand denominated, but the underlying assets are predominantly in USD (66%).
- Inflation adjusted returns are generous or conservative, I’ll let you know later
|Asset Class||Inflation Adjusted Return|
Building the Model – Questions to be answered
Question 1 – RA or CGT Route – Straight Comparison
Question 2 – What should the balance be – Life is seldom binary and building one on top of they other.
Question 3 – Phased – What if I did one, then then other.
Scenario – R300k per year, with annual expense of R180k
|RA or CGT||18 years until CGT is preferable||Works out to a 26.3% contribution and gives 57% expense coverage after 18 years.|
It would take 25 years to reach FI with an RA and 24 with CGT.
|Balanced||As per the straight shoot out||Taking 20% off expenses would shorten FI by 30%.|
|Phased||Over 30 years, first 15 on CGT and last 15 to RA||It aligns with the tipping point.|
Scenario – R600k per year, with annual expense of R360k
|RA or CGT||28 years and only then does CGT is preferable||Once post retirement income surpasses current income, the CGT option becomes preferable. |
Dropping annual expenses would shift this tipping point to earlier.
|Balanced||At 28 years, dropping the RA contribution from 23% to 7.1% is optimal. Increasing net cash each year by 2.93%||As tax rates increase, a balanced approach becomes more interesting|
|Phased||Over 30 years, first 15ish all to CGT and last 15 max to RA, this increased the retirement amount by 2.7% each year on balanced.||These amounts are small %s, but I’m examining at the margins. In my case they were quite chunky.|
Scenario – R900k per year, with annual expense of R540k
|RA or CGT||31 years of investing before CGT becomes more attractive.||14.7% gets invested|
|Balanced||At 31 years, dropping the 14.7% to 6.5% increases net cash at FI by 2.82%.||Interesting that this person ends up poorer than the previous scenario.|
|Phased||Over 30 years, first 10ish all to CGT and last 20 max to RA, this increased the retirement amount by 7.1%||This would still leave the person short of FI. Higher earners often end up poorer.|
Scenario – Rxk per year, with annual expense of Rxk – Test it for yourself.
I’ve probably made some dumb assumptions and everyone’s circumstances are different. So I reckon you should have a go yourself.
Scenario – PF40 – How does this impact me?
I changed the assumptions to fit my personal context, for example, I believe as long as I’m not at lean FI, I can use a 6% draw down rate, but need to watch it. I can reduce expenses or supplement my income. I’m also expecting to increase expenses after FI depending on the next adventure.
With my numbers. It takes 14 years before CGT is preferable, but by then I am targeting being FI for about a decade. After 4 years (My FIRE target), I’d be better off with an RA, but I couldn’t access it. It’s also a bit moot, as my investment rate is 48% on gross salary and 71% on net (which is probably a better like for like of the 76% RA rate), so well beyond the 27.5% allowed. Even assuming I maxed it, I couldn’t find a phased approach, beyond a few years, where it was beneficial.
For me, it’s CGT route offshore for the foreseeable future. I have a pension, which if I don’t touch until I’m 67, which should leave me comfortable (or at least give me a great chance of being comfortable).
Of course – Increasing the savings rate, still has a far bigger impact that choosing which vehicle to invest in.
What is your tipping point? Should you change your balance?