Income and a “Rule of Thumb”

Proposed Tax Changes Affecting Trusts
August 29, 2016
Revised Special Voluntary Disclosure Programme
October 3, 2016
Proposed Tax Changes Affecting Trusts
August 29, 2016
Revised Special Voluntary Disclosure Programme
October 3, 2016

Harbour Wealth-01

Back in 1782, James Gillray published a satirical cartoon “Judge Thumb”. The cartoon lambastes a certain Sir Francis Buller, an English judge, for allegedly ruling that a man may legally beat his wife, provided that he used a stick no thicker than his thumb, although there is no other written record of Buller making such a pronouncement the origin of the phrase “rule of thumb” is often attributed to this event.

As we pay tribute to our wonderful women with National Woman’s Day in August it is most gratifying that times have changed and we hope all our Harbour ladies are spoiled and pampered on the 9th.

Where does the “Rule of Thumb” come in to a Harbour Newsletter you are possibly wondering?

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In 1994 research submitted by William Bengen titled “The Four Percent Rule” advocated that a 4% draw on capital could provide a sustainable income and preserve capital. This was followed by the influential 1998 Trinity study conducted by three professors of finance at Trinity University who enhanced the studies of Bengen with the goal to determine the “safe withdrawal rates”. They too concluded that a “safe withdrawal rate rule-of-thumb” was also 4%. Bengen did, however, revisit his theory in 2006, upping his factor to 4.5%! There is vast research available on this topic that elicits much debate amongst financial planners and developers of planning software!

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The Association of Savings and Investments South Africa (ASISA) provides the table, below, as a guide for Living Annuities. As can be seen a person drawing 5% from their Capital would require at least a 10% annual return to sustain an income for a period of 33 years and this is just a guide, a rule-of-thumb, not a guarantee!

Another explanation of origin of the saying “rule-of-thumb” arises from artists and artisans who measured and estimated, often very accurately, with no more than the top of their thumbs!

And like those inclined to squint at their thumbs when tackling a vexing issue one can also use a simplistic 5% rule-of-thumb as a starting point when contemplating your Retirement and Risk cover (life, disability and dread disease) and the amounts needed to replace INCOME!

  • If I die today – how much life cover will I need to provide an income for my family?
  • If I was unable to work – how much capital would I need to replace my income?
  • When I retire – how much will be enough to provide an income?

Using basic 5% rule-of-thumb one can estimate – every R 1 Million invested Capital can provide R 50 000 annual sustainable income! Or R 4 167 per month, a scary number made even more so by the ravages of inflation as that R 4 167 is “todays value”!

Even an impressive sounding Life Cover Policy of R 5 Million, as a rule-of-thumb, will provide dependents with an estimated sustainable income of “only” R 20 833pm.

The retirement conundrum of: How Much Do I Need to Save? Can be approached with the 5% rule-of-thumb by starting with the question: If I retired today how much income would I need monthly to live the life I would like to live in retirement, in today’s value? Using the above numbers for simplicity sake let us assume that your answer to this question is R 20 000pm –

You would, then, need R 5 000 000 Capital today. BUT you are not retiring today! Your R 5 000 000 must then be converted to a Future Value taking in to account expected inflation and the number of years (term) until your planned retirement. (An example: A Present Value of R5 000 000 in 20 years-time with inflation at 6% will require a Future Value of just over R16 000 000 and your equivalent R 20 000 pm would need to be +/- R 66 500 pm in 20 years to provide the same standard of living)

  • Take a moment to consider the total Life Cover you have in place and what 5% of the total amount would be as an income for your dependents?
  • Now do the same for with your current Retirement Provisions – What would 5% of the total amount give you as an income today?

 Wait – DON’T PANIC!

While these rule-of-thumb estimations provide valuable insight, it must be stressed that there are numerous additional factors and permutations to be considered and factored in to a Sound Financial Plan to avoid it being simply a thumb suck.

At Harbour we don’t stare at our thumbs – nor do we sit on them! We are actively committed to enhancing the financial positions of all our clients and their families.

Financial Planning: We, at Harbour, are in the final stages of the development of a world class Financial Planning Tool that will allow accurate and meaningful solutions and options for our clients.

Income Provision: We, at Harbour, have also actively challenged conventional methods used to structure Capital Investments that provide an income. This is an issue very close to our hearts as many of us, at Harbour, are currently managing the investments that provide incomes of our parents and our parents contemporaries. We have developed, and are constantly enhancing, a very specific strategy for the provision of income One that is proving both mathematically and practically to be very efficient in managing the sustainability of the capital.

Costs: As Eugene always says “Performance is a Promise; Fees are a Fact!” Excessive Costs and Fees erode performance and can severely limit Capital Growth. We, at Harbour, are very aware of this and are constantly looking for the best options for our clients. As an example of the impact of costs: If you are drawing 5% annually from your capital – a saving of 1% annually in fees can be seen as a 20% increase in your income!

While the rule-of-thumb estimations are a valuable starting point in assessing your needs a sound, professional and comprehensive Financial Plan is ESSENTIAL!

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Travis Wilkinson

Senior Wealth Manager

 

If you would like more information, please contact your Wealth Planner or visit our website www.harbourwealth.co.za

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

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