By Zaakir Enoos, Consultant
We have all heard the age-old saying ‘saving for a rainy day’. But what is a rainy day, which options are available to you, and how do you know which one to choose?
Saving for a rainy day comes down to building up a reserve (pot of money) in preparation for a future need, at a time when you really need the money – as opposed to this week, month, or even year.
In this article, we look at ways in which people have been saving for a rainy day over the history of time and provide you with some options available to you for your future needs.
Before banks were around, people would mainly use informal ways of saving. This took the form of storing money at home ‘under the mattress’, so to speak, or via a savings club such as a stokvel.
Under the mattress
This savings practice has been around for many years. It appeals to those who want immediate access to their money and it comes with no transactional costs. The downside is that you won’t be earning interest, so there is no growth potential and the value of your money will be negatively affected by inflation.
This is an informal savings plan set up by a group of people who save a regular amount each month, e.g. R100.00. Each person then gets a chance to have the month’s collected cash. This method of savings is used by many South Africans; according to the National Stokvel Association of South Africa, the stokvel economy is estimated at R49 billion!
The minimum contributions to stokvels are generally very low – in fact, they are at the discretion of the people forming the stokvel. However, an important element of the stokvel model is trust. Members have to be fairly confident that the other members will keep up their monthly payments, especially after having received the cash.
As society grew and became more sophisticated, so did the savings needs of society, and as such banks and financial institutions came about. Various forms for formal savings developed in this time and banks and financial institutions became prominent role players in offering savings vehicles.
Let’s take a look at some of these saving options available today:
Most people are familiar with a bank account and are holders of a transactional bank account with a reputable South African bank. In addition to transactional accounts, banks and financial institutions offer other short-term and long-term saving options. Let us preview some of the popular options available. Bear in mind that all contributions to these saving options are made with after-tax money.
- Call accounts
Your money is on call, which means it can be withdrawn at very short notice (usually not more than 24 hours). Interest rates fluctuate while your money is invested. This option provides you with an opportunity to earn interest, unlike the old ‘under the mattress’ savings plan.
- Notice deposits
Your money is invested indefinitely and only becomes available after a pre-specified notice period (e.g. 32 days) has been served. Interest rates on such investments are generally higher than those on call accounts. The key here is the longer the period, the higher the interest rate.
- Fixed deposits
Your money is tied up for a set time period, usually ranging from one month to five years. Although interest rates are usually fixed for the period. Interest rates on these deposits are generally higher than those on call accounts. As with notice deposits, the longer the period, the higher the interest rate. Here you commit to a longer-term investment, generally for a greater reward.
Sound like a big concept? Well, let’s break it down. Simply put, a unit trust (collective investment scheme) is a pool of money from various people which is used to invest in a variety of asset classes, such as equities (shares), bonds, property and cash.
The pool is then divided into equal units where each unit contains the same proportion of assets in the pool. Investors then share in the pool’s gains, losses, income and expenses.
This option is generally available from banks and financial institutions. It remains one of the most favoured entry points for first-time savers in South Africa.
This option appeals to many, as you have the potential to grow your money substantially if invested for the long term and you have the flexibility to stop your investment or access your money at any time – especially in emergencies.
Tax-free Savings Account (TFSA)
This type of account was introduced by Government in 2015 as a tax incentive to individuals who want to save some of their after-tax money. All proceeds, which include interest income, capital gains and dividends from these accounts, are tax free when drawn. You are able to make contributions of up to R33 000 per annum, with a R500 000 lifetime limit. This account could take the form of unit trusts, exchange traded funds, fixed deposits, retail savings bonds or bank savings accounts registered as a TFSA.
Be mindful as every product provider, i.e. bank or insurer, will have their own specific terms and conditions, so investigate the product before you start contributing.
As society moved on, employers became an important cog in the saving system. They made saving for retirement an employment benefit, which became available as a condition of employment. So let’s take a look at retirement saving options.
Up until now we have been exploring saving options which you may contribute to with after-tax money. Below are options in which your contributions are tax deductible.
Retirement annuity fund
This can be seen as a personal retirement plan which enables people who are self-employed and who do not have access to an occupational retirement fund, to save tax-efficiently for retirement. Both lump sum and regular monthly contributions may be made to build up retirement savings for individuals when they can no longer work and need to retire. What is important to note is that this form of retirement savings may only be accessed from age 55 and older.
Retirement funds (pension or provident)
Contributions to a retirement fund – As a condition of employment, you belong to a retirement fund and contribute at an agreed contribution rate. You have the opportunity to change your contribution rate at a specified date annually. Importantly, these contributions are tax deductible.
In addition to your normal contributions to the fund, you may also make additional voluntary contributions to your retirement fund.
Additional voluntary contributions (AVCs)
Generally, as a member of a retirement fund, you are able to make monthly AVCs or a lump sum AVC towards the fund. These are additional contributions towards your retirement fund that are deducted directly off your salary via the employer’s payroll. The additional contributions allow you to boost your retirement savings and carry no administration fee, i.e. it costs you nothing to make AVCs to your retirement fund. You will benefit from the favourable investment fees achieved through the economies of scale associated with the collective size of the fund’s investment. In addition, you will also benefit from solid investment returns which are tax free.
Although retirement may seem many years away, investing just a little bit extra, by making an AVC, will have a huge impact on your pension one day.
From the above one can see that saving for a rainy day can take many shapes and sizes. Each option has its own unique attraction but what remains true to all is that saving some extra rands will make a lot of sense.