RETIREMENT PLANNING

RETIREMENT AND INCOME: MAKING THE CHOICE THAT’S RIGHT FOR YOU

By Jurie de Kock | Financial Planner | PWM Cape Town

Investor confusion is an increasing phenomenon nowadays, arising as a natural response to the ever-growing volume of data and information investors are bombarded with daily. Currently, a stream of podcasts, news articles and opinion pieces constantly compete for our attention. The result is confusion, uncertainty, and investor fatigue. For retirees, this barrage can be downright frightening.

In a world where investors are increasingly seeking guarantees, retirees are no different, but do guaranteed annuities really provide the right retirement solution for you?

CASH FLOW SCENARIOS

When preparing for retirement it is essential to understand your financial needs in retirement, to be able to address the key question currently affecting all retirees: How long will my retirement capital last (and is that going to be long enough)?

A cash flow scenario is a tool designed to answer this exact question. It is essentially a table showing starting capital, income drawdown and return assumptions on your capital. It shows how many years your money will last into retirement (and at what age you will run out of money). This is the cornerstone of sound retirement planning.

Assume you will live longer into retirement than your parents and grandparents, etc.

Increased longevity is a very real phenomenon in our modern world, and your retirement plan should reflect this (the longer you live, the more retirement capital you will need).

Remember to examine the key assumptions used in your retirement cash flow scenarios, as these determine the accuracy of the plan (and therefore the relevance to your specific situation and circumstances). These assumptions typically include retirement age, starting capital, income required, annual income increases, and investment returns achieved. Ideally, this should reflect a conservative view of your financial situation in retirement. Also try to build some leeway into your retirement budget to cater for the unexpected and, if possible, have some cash on hand to fund these eventualities.

Once you have a firm grasp of your income needs it is time to make an annuity selection. This is where the “compulsory” money will be invested, including money from retirement annuities (RAs), pension funds, provident funds and preservation funds.

The current annuity options at retirement are:

  • Living annuities (LAs); and
  • Guaranteed annuities.
LIVING ANNUITIES

An LA is effectively a basket of assets from which an income is withdrawn. The income is limited by legislation to a range of 2.5%-17.5% p.a., which can be changed on an annual basis. Returns are not guaranteed and depend on the underlying investment portfolio returns.

LAs must be constantly reviewed to make sure that a sustainable level of income is chosen (to avoid depleting the retirement assets). If properly managed, LAs offer retirees a way of drawing a flexible income during their lifetime, and then leaving the remaining assets to their nominated beneficiaries on death.

The advantages of an LA include:

  • Income flexibility
  • Beneficiaries receiving the remaining asset value on death
  • Assets within an LA grow free of tax
  • The ability to convert an LA to a fixed annuity at any time during retirement
  • Investing 100% offshore.

The disadvantages are:

  • Income is not guaranteed.
  • There is a risk of depleting assets and experiencing a reducing income in later retirement years.
GUARANTEED ANNUITIES

Guaranteed annuities are designed to take the worry out of retirement by providing guaranteed income (and guaranteed annual income increases) for life. The rates offered are based on age, gender and prevailing interest rates. Annuity rates change every week and will increase the older you get. Both spouses can be covered, providing income security for both, for life.

The advantages are:

  • Income is guaranteed for life.
  • Annual increases are guaranteed for life.

The disadvantages are:

  • There is corporate risk (the insurer guaranteeing the income must be around to pay it).
  • Capital is forfeited on the death of the last life assured (after any guaranteed term has expired).
  • Inflation risk – there is usually a cap on annual inflation-linked increases, so high SA inflation will erode the real value of income over time.
  • Once money is invested in a guaranteed annuity it can’t be switched to an LA at a later stage.
WHAT IF MY RETIREMENT CAPITAL DOESN’T PRODUCE ENOUGH INCOME?

Consider reviewing the guaranteed terms and increase options selected on guaranteed annuities (as these affect the income offered). It is also advisable to source multiple quotes, as each insurer offers a different annuity rate.

Consider increasing the income drawdown percentage of your living annuity. However, it is very important to remember that the higher your percentage drawdown on your capital, the higher the investment risk you need to take on, for your capital to last. If you don’t adjust the risk, your capital will run out sooner.

The next step would be to revise the retirement budget and cut down on expenses (this is not a fun exercise). Remember to apply for state benefits on offer.

Do you qualify for Government’s old age grant to supplement your income? You can access information on the grant on the SA Social Security Agency (SASSA) website.

IN SUMMARY

Seeking competent advice is highly recommended, as the choice of annuity will have a lasting impact on your retirement finances. There is a plethora of options within each annuity, and the retirement capital can even be split between a guaranteed annuity and an LA, in order to provide a guaranteed income underpin as well as investment/income flexibility. Alternatively, start with an LA and “buy” guaranteed annuities as time goes on when the rates are more beneficial.

Assess the options within each annuity and tailor the income to your specific needs and circumstances. Finally, remember to regularly revisit the retirement cash flows with your financial planner, to make sure your retirement remains on track.

Disclaimer:
The name(s) and the example(s) used in this article are for illustration purposes only. Each person’s circumstances are unique and should be assessed on their own with a financial planner before deciding on any action steps.