You can’t pour from an empty cup
A healthy focus on financial self-care could be a tonic in retirement.
Having an income that lasts and leaving a legacy are often opposing ideas. Practically speaking, choosing an annuity product with the intention to provide for your dependants when you pass away, could actually result in you being dependent on them in the late phase of retirement. Rather than being conservative to leave money to heirs, focus instead on reducing your risk of depending on your loved ones later in life.
Self-care is not just a matter of looking after yourself physically, mentally, and emotionally. It also means looking after yourself financially.
Ideally saving for retirement should begin with your first paycheck as you can’t expect less than 40 years of saving to pay for 40 years of retirement. Given the fact that people are living longer, this could be a real possibility.
At retirement, if you are retiring from a pension fund or a retirement annuity you can take up to one third in cash and the remaining two thirds must buy an income generating product such as a life annuity or a living annuity. For provident fund members, the rules are slightly different as legislation changed in 2021. Obviously, it’s beneficial if you can avoid taking the cash, and rather add that to your capital when you buy an annuity.
Since they were introduced in the late 1990s, living annuities have been the choice of the majority of South Africans when they retire. They like the fact that living annuities are more flexible than life annuities, as well as the fact that you can leave capital to heirs.
Living annuities enable retirees to draw down different levels of income, within certain limits, and to change this amount every year. A recent study of around 20% of the living annuity market revealed an average drawdown rate of 8.5% per year, when in fact considering the respective ages and sexes of this group of lives, the average safe drawdown rate should be 5.3% per annum. The propensity for high draw down rates in the early phase of retirement, may mean you have to try recover in the active or passive phase, but by then the risk of outliving your income in the late phase is already at dangerous levels.
Notwithstanding, investment markets haven’t been performing very well, which means it has become increasingly difficult to achieve enough investment growth for a living annuity to offset the detrimental effect of higher drawdowns. There is also the issue of rising inflation, which has eroded the buying power of many retirees’ incomes.
There is also a common inclination to take out a living annuity at retirement and then switch to a life annuity only in the late phase of retirement, to guarantee the income for the rest of your life and avoid running out of money. However, the misperception is that the later you wait to buy a life annuity, the better the annuity rate. While it’s true that annuity rates are higher for older ages, they are not better value for money. For example, the only reason that you can buy a life annuity at age 70 with an annuity rate of, say, 10%, versus buying one at 65 with a rate of 8.5%, is that at 65 you’re buying 5 more years of income.
As the saying goes, you can’t pour from an empty cup. The actions you take today to ensure that you don’t end up outliving your income, particularly in the late phase of retirement, are important and ideally should be discussed with a financial adviser.
Some considerations include:
- Start saving for retirement from your first paycheck.
- Educate yourself about investment products. If you don’t have a company pension plan, take out a retirement annuity as soon as you possibly can. The minimum contribution of most retirement annuities is R500, and your contributions are tax deductible.
- Plan for retirement from the outset with the help of a qualified financial adviser. They can, help you estimate how much you’re likely to need to suit your desired lifestyle.
- Before you retire, make sure you understand the differences between retirement income products like life and living annuities, and the benefits and drawbacks of each so you can make an informed decision.
- If you’re already retired and you invested your savings solely in a living annuity, consider switching some of it into a guaranteed life annuity or investigate the benefits of a blended annuity. Remember, investing only in a living annuity for the duration of your retirement is only appropriate if you’ve saved enough capital to give you a sustainable income for life.
Article by: Clive Lazar, Business Development Manager