Botha et al. (2014a:25) identify the different financial planning components as personal financial management, investment planning, risk management, health care planning, tax planning, business financial planning, estate planning, and retirement planning. Figure 2.2 illustrates these financial planning components.
Figure 2.2: The components of financial planning
Source: Researcher’s own construction A discussion of each component follows.
2.5.1 PERSONAL FINANCIAL MANAGEMENT
Botha et al. (2014a:25) state that personal financial management involves the analysis of an individual’s cash flow. A budget is usually compiled to determine how an individual’s income is spent, and is a useful tool in personal financial management to identify any disposable income that might be used to make investments (Botha et al. 2014a:25). Personal financial management identifies any debts an individual might have, and the repayment conditions for such debts. In addition, personal financial management establishes a fund for emergencies that an individual can access at short notice. (Botha et al. 2014a:25; Cull 2009:27; Altfest 2004:53).
2.5.2 INVESTMENT PLANNING
Another dimension of financial planning is investment planning. According to Altfest (2004:53), proper investment planning occurs where the use of financial resources is maximised with the aim of creating a financially sustainable future. An individual’s investment portfolio must be analysed to investigate its tax effectiveness, the risk and rates of return, diversification, maturity dates, and liquidity. Real assets, in investment terms, are assets that can be used to produce products/services, such as machinery or property. Financial assets are assets such as shares and bonds (Bodie et al. 2009:2). In investment planning, decisions about the investment portfolio (including real and investment assets) must be taken in order to determine which assets must be retained, which assets must be adapted, and which assets need to be disposed of, in line with the financial needs and goals of the individual. The investment strategy implemented in investment planning must consider how the income from the investment portfolio is generated, as well as how wealth is created and protected in the composition of the investment portfolio. (Botha et al. 2014a:25; Cull 2009:27; Smith 2009:83).
2.5.3 RISK MANAGEMENT
Cull (2009:27) mentions that risk management can also be considered a dimension of financial planning. Risk management involves the assessment of an individual’s exposure to risk, along with the incorporation of insurance and other practices to establish and limit an individual’s exposure to risk (Altfest 2004:53). Various types of risk can affect an individual. For instance, personal risk management aims at determining the capital and income needs of an individual in the event of death, disability, or dread disease. In addition, losing the ability to earn income is one of the most common forms of personal risk an individual can experience (Harrington & Niehaus 2003:5). Another type of risk is property risk – the loss of or damage to motor vehicles, a home or its contents, or the loss of or damage to personal property. Liability risk is associated with property risk, and is the risk that an individual might be held accountable for damage to the property of another individual. In addition, investment risk pertains to the risk of an underlying investment losing its value. Once the type of risk has been identified, the financial planner must assess and evaluate the impact of the risk. Since financial planning, holistically, deals with the creation of wealth as well
as the protection of wealth, insurance is an important part of risk management. Insurance is a way of transferring financial risk: an insurer contracts to take over the risk in exchange for a premium. Insurance is an important aspect of risk management, as it ensures that risk is mitigated effectively. (Botha et al. 2014a:215-221; Hopkin 2012:2; Irving 2012:50; Valsamakis, Vivian & Du Toit 2010:45; Smith 2009:83).
2.5.4 HEALTH CARE PLANNING
Botha et al. (2014a:19) state that it is important for a financial planner to have a basic understanding of health care benefits that are available to an individual. In South Africa, health care services are provided predominantly through private medical aid schemes, membership of which is voluntary. Many South African individuals who do not have health care insurance rely on the state for both specialist and hospital services. The public health care system is free for South Africans who cannot afford to pay for these services. Individuals who require private medical services are required to finance medical services privately, should they require private doctors and medication from private pharmacies. (Botha, Du Preez, Geach, Goodall, Palframan, Rossini & Rabenowitz 2014b:195). Individuals with no provision for health care should factor health care into their financial plans. Where necessary, the individual must be referred to a specialist health advisor to deal with this aspect of financial planning.
2.5.5 TAX PLANNING
As part of the financial planning process, Botha et al. (2014a:27) state that it is imperative that a financial planner knows the tax laws applicable to an individual’s financial plan. A financial planner must also have a comprehensive understanding of an individual’s tax situation in order to advise the individual accurately (Botha et al. 2014a:27). Without knowledge and understanding of taxation, a financial planner might make recommendations that result in a tax situation that disadvantages the individual. There are a number of different taxes to which an individual in South Africa might be subject. For instance, income tax is tax paid on any cash receipts or accruals an individual might receive. Capital gains tax refers to the tax imposed on an individual upon the disposal of an asset. Another type of tax is donations tax, the tax imposed on an individual when they make a donation (Botha et al. 2014a:708). In addition, value-added tax (VAT) is the tax levied on all products/services supplied by a
registered vendor (Botha et al. 2014a:731). Therefore, VAT can impact the financial situation of an individual who owns a business that provides products or services that are subject to VAT. Another type of tax to which individuals might be exposed is transfer duty – a tax that is levied on the value of any immoveable property, such as land, that was acquired by means of a transaction (Botha et al. 2014a:742). As part of tax planning, estate duty is a tax that is levied on a deceased’s estate (Botha et al. 2014a:753). Altfest (2004:53) elaborates that minimising the taxes an individual incurs is a vital aspect of tax planning; so a financial planner must be knowledgeable in all spheres of tax that affect individuals. (Botha 2012:195; Irving 2012:50; Cull 2009:27; Smith 2009:83).
2.5.6 BUSINESS FINANCIAL PLANNING
Business financial planning encompasses the business assurance needs an individual might have if that individual is self-employed. A financial planner must consider the type of business entity of the individual’s business, and determine the business insurance strategy applicable to the particular business. Botha et al. (2014a:1003) explain that each business has an employee who is vital to its operations and to the overall success of the business, whether it be an engineer or a managing director. The premature death of such a key individual can result in severe financial loss for the business, and it can be difficult to replace the skills or expertise of such an individual (Botha et al. 2014a:1003). Therefore, key-person insurance is taken out to provide the business with income to remain operational and to have funding available to recruit and train a new individual. A financial planner must also determine how important it is for the business’ financial planning goals to secure an overdraft in order to protect the credit facilities of the business in the event of the death of the owner of the business. A cover for personal guarantee can be purchased to protect the personal assets of the business owner, and to provide cover for the business in the event of the death of the owner. According to Botha et al. (2014a:1004), contingent liability insurance can be purchased to cover shareholders’ loan accounts, should the business not be able to repay a shareholder’s credit loan account when necessary. In the event of the premature death of the owner of the business, insurance cover is purchased on a mortgage bond to ensure that the business property is not claimed back by the bank if there is an outstanding amount on the bond (Botha 2012:56). Insurance cover can
also be purchased to provide cash reserves for the business or to meet future contingencies in financial emergencies. (Botha et al. 2014a:1004; Botha 2012:56; Irving 2012:50; Cull 2009:27; Smith 2009:83).
The insurance needed to provide employee benefits can be considered part of business financial planning. According to Botha et al. (2014b:517), employee benefits refer to the various ways in which an employer can provide fringe benefits to an employee that are non-monetary, such as a retirement fund, life insurance, disability insurance, funeral assistance, or medical aid scheme membership (Botha et al. 2014b:517). Certain employee benefits, such as retirement funds, are tax-deductible for the employer. It is thus important for a financial planner to be knowledgeable about employee benefits for those individuals who are business owners and who would like to provide benefits for their employees. (Botha et al. 2014b:517).
2.5.7 ESTATE PLANNING
Estate planning consists of the arrangement and management of an individual’s estate so that the individual’s family and beneficiaries can continue to use the estate and its assets after the individual’s death, irrespective of when the death might have occurred (Botha et al. 2014a:855). Estate planning consists of the calculation of the estate duty payable, and determining whether sufficient funds are available to cover the liabilities in an estate that is being liquidated and distributed. Liabilities that might be incurred are the executor’s fees and the income needs of the deceased’s spouse and dependants. (Botha et al. 2014a:27). Various strategies are involved in estate planning, such as measures to minimise the estate duty payable, investment strategies, and the strategy of transferring assets to a spouse. As part of estate planning, testamentary planning involves the financial planner ensuring that an individual has a valid and up-to-date will. Upon the death of the individual, the financial planner must bear in mind the individual’s requests about the distribution of assets to various heirs and other beneficiaries. (Botha et al. 2014a:27). The financial security of the spouse and of any dependants an individual might have is another dimension of testamentary planning. Finally, testamentary planning considers the provision of guardianship and maintenance for minor children, should there be any. (Botha et al. 2014a:27; Botha 2012:169; Irving 2012:50; Cull 2009:27; Smith 2009:83; Altfest 2004:53).
2.5.8 RETIREMENT PLANNING
Retirement planning refers to planning for the time when work-related income will cease (Altfest 2004:53). Alternatively, retirement planning pertains to making financial provisions for retirement, such that an individual meets the set retirement goals and is able to live comfortably during the retirement years. More importantly, retirement planning ensures that an individual eliminates the risk of outliving the retirement provisions. Retirement planning involves more than contributing to a pension fund, provident fund, or retirement annuity fund: it assists individuals in reaching their retirement objectives by also taking the tax laws that govern retirement funds into account. Investment knowledge and time value of money calculations form part of proper retirement planning, and are equally important in the financial planning process. (Botha et al. 2014a:951).
To ensure the financial security of an individual at retirement, retirement plans need to be made as soon as possible (Botha et al. 2014a:27; Irving 2012:55). Financial planning for retirement comprises three phases (Botha et al. 2014a:951). The pre- retirement planning phase is when an individual would begin accumulating retirement provisions whilst still working. A financial planner must be able to advise the individual whether they will have sufficient retirement capital upon reaching retirement in order for them to receive an income to live comfortably during the retirement years. (Botha et al. 2014a:951). The second phase of retirement planning occurs once an individual has reached retirement age. The impact of tax on the retirement benefits of individuals is determined in this phase, as taxes are imposed on retirement benefits. The final phase of retirement planning relates to planning after retirement. In this phase, individuals might need investment advice from a financial planner about their retirement capital. (Botha et al. 2014a:951). Botha et al. (2014a:27) state that few individuals prepare for their retirement and that, upon making retirement preparations, they do not take the impact of inflation on their retirement benefits into account. Therefore, a financial planner can play an important role in assisting individuals to be financially prepared for retirement. (Botha et al. 2014a:951; Botha 2012:89; Irving 2012:50; Cull 2009:27; Smith 2009:83).
As the purpose of this study is to investigate the retirement funding adequacy of black South Africans, the next chapter will discuss retirement planning in more detail.