BUSINESS MAVERICK OP-ED

About to retire? Take great care

By Bruce Cameron 22 June 2020

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, says the writer. (Photo: Unsplash / Marten Bjork)

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.

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:

  • You still haven’t saved much and are well short of capital, as is the position for most members of retirement funds.
  • You are being retired early, as your employer wants to hire younger, less costly workers.
  • Your job has been made obsolete as a result of the crises we are still navigating, and your position is looking far worse.
  • Your underlying investments were very underweight in terms of foreign investments.
  •  You are being forced to take early retirement at age 55, have not saved very much in the past, and your investments have not been great. This is a worst-case scenario.

Plan ahead

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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:

  • Whether you can afford to retire: If you can’t, then you must consider other options. For example, continue working at your existing job, if you can, or try to find another one, or create your own. Avoid using the third choice of using your retirement money on a business in case the new venture goes bankrupt. The sooner you get a new job or start a new career, the better: as you get older and/or sicker, the option will become more difficult.
  • How much you will earn from an investment-linked living annuity: You need to compare this with your proposed drawdown rates and your investment returns.
  • How much you would earn from a guaranteed annuity, particularly one that increases by a fixed amount each year or in line with inflation, or a with-profit annuity, where you take some of the risk in that your future income depends on the profits made by the fund.
  • How to plan for your wants and needs: If you decide on a hybrid annuity, using a living annuity with an underlying guaranteed annuity to provide for your basic needs, you should then divide the total amount. So, say, of R20,000 income, R15,000 a month is to meet your needs, while the balance is for your wants and luxuries. A typical retiring couple could secure R15,000 a month in a guaranteed annuity for R3.6-million, leaving the balance of R2.4-million to be invested flexibly. This calculation will tell you if you have enough to meet your basic needs and how much you will have remaining for luxuries.

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:

  • Plan your retirement income needs up to age 95 for males and 100 for females, as you have a 10% chance of surviving to that age and it is horrible if you have no money. In the Just Retirement Insights survey conducted in 2019, which had 524 respondents, 83% self-assessed as being financially astute even though 53% had not calculated how much they would need a year for their retirement income and had not overestimated what they believed they could draw sustainably from their capital at retirement.
  • Think about deferring your retirement if you can or finding other ways to source an income (because this gets harder after each year in retirement). You will save more and therefore be able to sustain yourself longer.
  • Divide your retirement savings into two pots:
  1. One pot can be your essential expenses. A life annuity, whether it’s a standalone or part of a hybrid, gives you certainty of income for life. You must do the research and plan for when you expect to do things, such as selling your home and moving into a retirement village. When you decide to change, you must first assess all the selling and buying costs to assure it makes sense.
  2. A second pot can be used for flexible spending (if there is any left, it will be a legacy to your beneficiaries). People who have little interest in financial markets often use funds where they can let investment professionals make the decisions. There is never any one-way, especially in the short term: some people regard the rand as a one-way bet, but it tends to move significantly every few years and then trends back to a more normal level over time.
  • Consider the tax advantages of a “voluntary purchase” annuity. This is a life annuity purchased from your personal savings. The income you receive each month is split into two components:
  1. A return on the capital you invested in the voluntary purchase living annuity that is paid tax-free: and
  2. The investment-return portion on which you pay income tax at your marginal rate as and when the income is paid to you.
  • The reason you are fully taxed on your income from a “compulsory purchase” is that when you made your contributions to your retirement fund, they were deductible from your taxable income.

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

Article corrected.

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