You are about to retire. Unfortunately, the money you have carefully built up suddenly seems to be a lot less after being hit by the Covid-19 pandemic, the Zuma regime and the value of the rand.
And if you fit into one of the categories below, your financial situation could be even worse:
The first thing you must do is speak to your retirement fund’s counsellor. This will not cost anything. And then follow up with a financial adviser.
One of the worst things about retirement is that most funds force you to take retirement at a certain age, normally between 60 and 65. This means you could work for 30 years, which is equivalent to setting an initial drawdown from retirement assets of 4% a year.
Most people are quite capable at 65 to continue working – and they should if they can. By adding five years to your working life, you can improve your retirement savings by about 20-30% and reduce the time you will spend living off your savings. So, instead of 30 years of working, the ratio becomes 35 years of working and 25 years of living off the income of your savings. This small change could make a big difference.
The practice by funds of fixing retirement date dates to a predetermined age is something that should be dropped. But that is another battle.
To gain a fairly accurate view of your income flow in retirement, you can use what is called the Rule of 300 with a 4% return.
The Rule of 300 takes the amount you spend every month and multiplies it by 300.
So, if you are spending R20,000 a month, you will need R6-million saved to retire on the same income. If you invested the R6-million, the amount should keep your income level aligned with annual inflation to last for at least 25 years.
One of the few pleasant things about inflation is that money invested should keep you in line with inflation. The reason for this is that companies sell goods and services at prices that link with and often beat inflation, which then reflects in their share price.
The Rule of 300 will give you a good idea of your financial situation:
The downside of the Rule of 300 is that market returns are never consistent. For example, along came Covid-19 and investments hit rock bottom. The future is now very uncertain. You definitely should not rely on past performance figures, particularly of generic investment markets.
Deane Moore, the chief executive of Just SA, says that “even if a person believes they have perfect foresight to take advantage of a short-term opportunity, I think they should still adopt the sensible principles to the core of their retirement solution and only seek to ‘bet on their hunch’ with a portion of their ‘flexible pot’ of assets”.
He says there are a number of principles that people who are about to retire must consider:
Note that there are some very smart and legal ways in which you can use both compulsory and voluntary purchaser annuities in combination to avoid tax. When you retire, you are allowed to take part of your retirement capital as a lump sum, and this could be invested in a voluntary purchase annuity. The progressive tax rates on a retirement lump sum are as follows: The first R500,000 is tax-free; for R500,001 to R700,000, a total of 18% is due on the amount over R500,000; for R700,001 to R1,050,000, a total of 27% is due on the amount over R700,000; and 36% is due on any amount above R1,050,000. You can take the tax amount only once, but it can come from more than one retirement fund.
If you sell your home and move into a retirement centre, which normally requires monthly levies, and/or you need extra income, a useful way to convert that capital is to transfer into a voluntary purchase annuity.
If you do a good job on this, you can plan to spend more in your early active years of retirement with confidence, because you have a clear plan on when you are going to scale down your living expenses and budget for that time of your life.
Let’s take an example of how delaying retirement will help you. This has been prepared by Just Life SA, using its data:
A couple (male aged 65, female 61) need R20,000 a month and have R6-million, which is sufficient in terms of the Rule of 300. This means, in accordance with the FSCA guidelines, they can draw 4% a year from a living annuity.
This same couple could secure a with-profit annuity that provides R25,000 a month guaranteed for life and which targets increases in line with inflation. In return for the higher sustainable income, they would need to give up the flexibility of how much they can draw.
Now, if they work for an extra five years, and we assume they save 20% of their salary each year and invest this conservatively to avoid any negative market impact, they would accumulate another 100% of their salary by the time they retire.
And let’s assume the R20,000 a month was at 65% replacement ratio on a salary of R30,000 a month.
They will save an extra R360,000 (R30,000 x 12 months). This means that their savings at retirement will have increased from R6-million to R6,360,000. However, this is now used to secure an income for a shorter remaining lifetime.
Using the draft FSCA tables, the couple are now five years older, and the FSCA recommends a drawdown rate of 4.5% as being sustainable, which is R24,000 a month (the Rule of 300 now becomes a Rule of 265).
Alternatively, they could secure a with-profit annuity that provides R32,000 a month guaranteed for life and which targets increases in line with inflation.
And, if they value flexibility and feel that their long-term essential needs in a retirement village could be met with R16,000 a month, they could get a hybrid annuity, allowing them to invest 50% (R3,180,000) in the with-profit annuity. This would secure their essential needs of R16,000 a month while either of them remains alive. A drawdown rate of 4.5% on R3,180,000 would give them a sustainable income of R12,000 a month, with the benefits of flexibility and capital legacy for beneficiaries. Or, in total they could receive R28,000 a month.
In this example, the couple have increased their income by 40% from R20,000 to R28,000 a month.
Let’s break this down more clearly: The couple increased their share of total savings by just 6% over five years, taking their retirement capital of R6-million to R6.36-million. This rose by 14% when they were five years older and could draw 4.5% sustainably from their living annuity instead of 4%. And they gained 20% from investing half of their retirement capital in a life annuity, which provides a higher sustainable income for life at 6% a year, instead of 4.5% a year to which they would need to limit themselves without that longevity protection. BM/DM
Next week: The second part of planning your retirement.
A series of reports written by Bruce Cameron, the semi-retired founding editor of Personal Finance of Independent Newspapers, that cover the effects of Covid-19 on pensioners including research undertaken by Alexander Forbes on retirement income in South Africa. Bruce Cameron is co-author of the best-selling book, The Ultimate Guide to Retirement in South Africa
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