Resigning shortly before retiring: Several factors to keep in mind

Question

I will be retiring at the end of the year after 40 years of service. My pension fund will pay me 2% of my final pensionable salary for each year of service.

One of my colleagues told me that I would be better off resigning a month before retirement, transferring the proceeds to a preservation fund and then investing the money in a living annuity.

He says I would have more control over my money and there would be something left for my children when I die. Should I do this?

Answer

On the face of it, the idea of resigning before retirement can sound attractive. You get a capital value that you can invest. You can decide how much income to draw, and when you die, the remaining money can be left to your beneficiaries. This sounds much better than receiving a pension that stops when both you and your spouse have passed away.

But retirement planning is not only about control. It is about certainty, risk, income, inflation, tax, medical costs and what happens to your family after your death.

A person retiring on 80% of their final salary is in a very strong position. Very few people retire on anything close to that. With a pension like this, your income is secure and guaranteed for life.

The trade-off is that you do not own a pot of money in the same way you would with a living annuity. Once you and your spouse have died, there is usually no remaining capital for adult children to inherit. This can feel unfair, especially if you have spent your whole life building up that benefit.

But you must be careful not to confuse “leaving capital” with “being financially better off”.

A living annuity gives you flexibility, but it also transfers the risk to you. If markets perform badly, inflation is higher than expected or you draw too much, or if you live longer than you thought you would, then you can run out of money.

You need to ensure that your funds are correctly invested and your annuity drawdown rate is sustainable. Remember, any drawdown rate above 5% requires careful structuring of the investments.

In addition, you may qualify for a post-­retirement medical aid subsidy. If you resign, you would probably lose this subsidy. Because medical costs are one of the biggest expenses in retirement, you must factor this into your calculations.

When resigning could make sense

There are situations in which resigning before retirement could make sense. If you are single, do not have a spouse who needs a ­pension and have adult children or dependants who would need access to capital after your death, a living annuity may be worth considering.

It may also make sense when you have a seriously shortened life expectancy and want to preserve capital for family members.

But for someone in good health with a spouse to provide for, and a defined benefit pension close to 80% of their salary, the starting point should be not to give up a guaranteed lifetime income unless the numbers clearly justify it.

Calculations that must be done

Before making any decision, ask for three calculations:

1. Ask the fund for your retirement pension, spouse’s pension and any medical aid subsidy details.
2. Ask for the resignation value and the tax consequences of transferring or withdrawing the benefit.
3. Ask a qualified planner to model the living annuity income needed to match the pension, including fees, inflation, market risk and what happens if you or your spouse live to 90 or 100.

You are not just comparing two products. You are comparing two different risks.

The defined benefit pension gives up flexibility and inheritance potential, but it gives you certainty. The living annuity gives you control and possible legacy value, but you take on the risk of poor markets and living too long.

With 40 years of service and a likely pension of about 80% of salary, be slow to resign before retirement. The guaranteed income is probably more valuable than it looks.

Run the numbers carefully, include the medical aid subsidy, stress-test the living annuity and only move if the evidence is overwhelming. DM

Kenny Meiring is an independent financial adviser. Contact him at 082 856 0348 or at financialwellnesscoach.co.za. Send your questions to kenny.meiring@sfpadvice.co.za

This story first appeared in our weekly DM168 newspaper, available countrywide for R35.