Think carefully about the decision you make regarding your retirement savings: remember this money needs to last for the rest of your life.
A pension fund or retirement annuity allows you to withdraw one third of you capital in cash, while you are legally bound to spend the balance on an annuity.
You are allowed to take the whole sum in cash when using a provident fund.
The key risks retirees face are longevity and inflation. Many think picking a product is an either/or choice, but the truth is you can actually combine them to offset these risks.
Guaranteed life annuities
This product will pay you a pre-determined sum for the rest of your life, which insures you against longevity. The rate is determined by your age and current interest rate, therefore a shorter life expectancy translates into a higher income.
There is a price though: Beneficiaries cannot claim any money after you die, since the insurers control your capital. There is sometimes an initial guarantee period that your family can use to claim if you die before the period expires. This option, however, does come with a decreased retirement income.
There are a few variations on the market therefore it is a good idea to shop around all companies to invest in and find one that fits your needs. Ensure that you understand the details before committing and be aware of the effect of inflation on your investments. Once you buy a product your terms are set for life.
A living annuity is more flexible. The income you receive is not fixed and performance is linked to the underlying investments. While it gives you more flexibility, it also comes with more risk. Longevity and market risk are particularly important so it’s best that you consult a financial advisor if you feel confused.
Asset allocation is your first big decision. Consider the growth you require and the risks you can take. Assets that show long-term growth potential are well worth considering.
Higher returns generally come with higher risks. These asset classes are typically volatile so you need to be certain you can weather the risks and choose the best unit trusts based on performance.
Your withdrawal rate is your next choice. You are legally required to draw between 2.5% and 17.5%. You are allowed to change your rate once a year, but be mindful of sustainability. The unknowns you face at this point are inflation, the real return on investment and longevity. Making rational assumptions and planning can offset these unknowns. Your standard of living during retirement and the longevity of the investment is influenced by asset allocation and withdrawal rate.
The hybrid approach
Your investment cycle doesn’t end with retirement. Use this time to generate more capital, while still drawing an income. Therefore it makes sense to combine guaranteed and living annuities.
It’s advisable to start with a living annuity and move to a guaranteed annuity. This allows you some flexibility and security. If you require more security then divide your savings at retirement and invest in both, with the option of transferring everything to the guaranteed annuity in the future. You can transfer from a living to a guaranteed annuity but not vice versa.
Retirement periods are getting longer and longer therefore it only makes sense to plan for sustainability. It is not the end of financial planning, but the start of a brand new phase.
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