Most financial planning campaigns are directed at the ‘Baby Boomer’ generation (born between 1945 and 1963) and Generation X (born between 1964 and 1980).
These will be the first generations that will retire without receiving guaranteed benefits from their employers. And it is generally accepted that most will have insufficient private savings to make up the shortfall.
The Baby Boomer generation and Generation X are getting the message and many are making desperate attempts to catch up the shortfalls in their retirement savings.
But the message does not seem to have filtered down to Generation Y, born between 1980 and 2000, the children of the Baby Boomer generation and Generation X. When confronted with the financial planning plight of their parents the general reaction is, ‘there but for the grace of God go I.’
Almost 20% of South Africa’s taxes are ploughed into education. Yet it is quite fascinating that universities and colleges seem to offer little or nothing in the form of general life skills courses to alert students to the fundamental mistakes they will make with their personal finances within the first five years after graduation. Some mistakes will haunt them for decades to come.
There have also been changes in lifestyle trends in Generation Y that impact on the finances to the Baby Boomer generation and Generation X. In particular Generation Y is remaining financially dependent on their parents for far longer. Gone are the days of dad’s famous words at his son’s 18th birthday party: ‘Go to the military, go to university, or go and get a job. But the important word is “go.”’
Off to a bad start
Prior to the global credit crunch most people had easy access to credit. Today this is restricted by the requirements of the National Credit Act. However, easy access to credit remains a reality for young graduates. Within months of graduation, former students are issued with gold and platinum credit cards before they have even experienced the reality of daily costs of living outside of the student environment.
This often results in a hopeless debt trap within the short term. And it takes many years for some young graduates to recover from the experience. Unless of course they receive a financial bailout from friends or relatives (usually within the Baby Boomer or Generation X categories).
Added to the credit problem is immediate access to cellphone contracts, clothing accounts and vehicle finance. Thus graduates land up owning an iPhone and an iPad before they even own an iRon!
Just 10 years ago it would have been a reasonable financial plan for a graduate to ‘buy a house as soon as possible and pay it off by age 35-40. There will be plenty of time to concentrate on a retirement plan thereafter’.
It is quite amazing that, in spite of the obvious difficulties within the residential property market since 2008, there is still a perceived urgency for graduates to enter the residential property market. Few realise that in many respects residential property has turned from asset to liability as holding costs have sky rocketed. Most would be far better off if they remained in rented accommodation for the short to medium term.
Today, many graduates are initially employed on limited duration contracts. Some employment benefits (medical aid, group life and permanent health insurance schemes, and retirement funds) are either not provided or participation is voluntary. Graduates actually prefer such packages as they increase disposable income in the first years of employment.
The standard rules of medical aids are usually that a student may remain on the parents’ medical aid, even after age 21. However separate arrangements have to be made after graduation. If the dependent wishes to remain on the parent’s medical aid, a full member’s rate will be charged.
The absence of group life cover for a new graduate is by no means the greatest risk to a family. But the absence of disability, permanent health and income protection insurance poses a substantial risk to the entire family. A health problem or accident of any family member has the potential to ruin the financial planning efforts of the parent as most parents would attempt almost anything to keep away from South Africa’s current health care system.
Some argue that Generation Y will benefit from the government’s plans for implementation of a national health insurance (NHI) system within the medium term. This project remains in its infancy and it will be many years before South Africa will be able to afford a comprehensive NHI system. Many predict that even if NHI is implemented, those who can afford private health care will remain on private medical aid.
There can be no doubt that today’s graduates are subject to substantial unavoidable risks when living in the new South Africa.
The good news is that graduates represent an extremely low risk to insurance companies. Over the years financial institutions have developed specific products to cover the risks of graduates. Thus, the costs of disability, permanent health and income protection insurance cover for graduates represent a fraction of the cost to the general public. These products are as much for the protection of the insured as they are for the insured’s family.
Some prudent parents even go so far as to facilitate medical aid, permanent health insurance and disability cover for their adult children, just to protect themselves. The cost of the premiums is a fraction of the damage to the parents’ financial plan should something go horribly wrong. There is no doubting the wisdom of this action.
Retirement planning for Generation Y
Generation Y can understand the attraction of the concept of making tax-deductible contributions to retirement funds. But it is extremely difficult to sell the prospect of tying up Generation Y’s investments in retirement funds until aged at least 55. In the past this was not of major concern as nearly every employer enforced some form of retirement fund contribution for all employees. Thus some form of retirement saving started from commencement of employment.
Previous generations may have received a substantial boost to their financial planning efforts through an inheritance from parents and family. However the increased life expectancy of the Baby Boomer generation and Generation X make this a distant prospect for most of Generation Y.
Today the world has moved away from the defined benefit pension fund towards provident and retirement annuity funds. And it has become all too easy for employers to allow employees to contribute on a voluntary basis until permanently employed or attaining the age of 30. This potentially loses the initial five years of retirement fund contributions. At first this would appear insignificant when seen in the context of a 40-year career.
However, Generation Y do not stop to consider the prospect that if they retire at 65 they may have to live in retirement for 30 – 40 years. Furthermore, the prospect of South Africa implementing a national comprehensive retirement plan is an even more distant goal than National Health Insurance.
Taking a retirement contribution of R1 000 per month, return rate 10%, and inflation rate 6%, the fund value after 40 years, in today’s terms, would be +/- R852 000. Over 35 years the fund value would be +/-R688 000. And over 30 years it would be +/-R544 000.
There can be no doubt that the need for retirement planning for Generation Y is as important as for the Baby Boomer generation and Generation X.
The National Treasury discussion papers released over the past two years have hinted at the prospect of enforced retirement saving requirements for all employees. This would obviously be a severe measure and it would be very surprising if such proposals are ever be implemented. But there is no denying that the need exists.
Many parents devote much time and effort to their financial planning without assessing the risk posed by their children. The stark reality remains that the social security systems of South Africa will be of little comfort or help should a disaster happen.
In as much as investment planning for retirement is essential for every employed South African, it is also of vital importance to assess the financial risks of the entire family. Fortunately the costs of insuring against the risks of younger family members, particularly graduates, are highly attractive.
Caption: Matthew Lester: Rhodes Business School professor, tax and financial planning specialist and now Biznews.com contributor.
By Matthew Lester