Wealth Journey Newsletter Winter 2019
Retirement is a major source of stress because of the loss of a regular income and the need to manage investments to last a full lifetime amidst increasing market volatility. Having a proper retirement investment strategy over one's working life is key. Technological and medical advances mean that we are also living longer, which can increase the risk of our retirement investments running out before we do.
For a couple retiring at age 60 today, the average life expectancy is 35 years. Unforeseen expenses in our retirement years are becoming more commonplace. The question is how best to structure our retirement income to provide a high level of security and peace of mind throughout our retirement years.
There are generally two options: a Life Annuity and a Living Annuity. The two sections below briefly explain their characteristics.
What is it? It's an investment that gives the investor flexibility to be able to invest in underlying investment funds and decide on their annual income within certain prescribed limits. The investor may decide to draw a slightly higher or lower income depending on the investor's income needs. It also provides flexibility to change service providers, change investment strategy or purchase a guaranteed annuity at any time.Any remaining capital upon death passes to the investor's heirs. In exchange for this flexibility, the investor takes on the risk that the income may not last for the full term of retirement, especially if income withdrawal rates are high.
Inflation is another key concern if the growth of the underlying funds do not achieve targeted benchmarks.
Suitability: Those who choose this option, do so mainly because they want to maintain control of their money. It is important that the investor should have or seek investment expertise to do this.
Considerations: Although the flexibility is attractive, it is important for the investor to realise that they take on all the risks - investment market and behavioural. The investor must therefore have the right strategy and stick to it.
What is it? It's an insurance product which provides an income for the duration of the life of a retiree. Income increases must be decided upfront. Investment market movements will not negatively affect the guaranteed income. Once the product has been purchased there is no flexibility to change - either in terms of income or switching to another product. Also, any remaining capital or income cannot be left to beneficiaries unless the investor has chosen a guaranteed term for income to be paid (so even if the investor passes away before the guaranteed term expires, the income will continue to be paid until the end of that specified term) or if the investor has elected a Guaranteed Joint Life Annuity (in which case the surviving spouse will receive a reduced income until their death).
Suitability: Those who typically prefer a guaranteed income expect to live longer, want peace of mind and are looking for financial protection in case of potential future cognitive decline.
Considerations: The insurer considers the health of the individual upon purchase by looking at lifestyle habits such as smoking and drinking, and conditions like heart disease and any life-shortening illnesses the investor may have developed.
The lack of flexibility means that unforeseen expenses cannot be funded through this solution.
It is clear from the above that neither of these options is perfect for ALL situations. To this end, clients may be well advised to follow a "blended" approach, to increase flexibility whilst decreasing risk. The following guidelines may help investors who are nearing retirement gain peace of mind without sacrificing the flexibility that may be required at times in their retirement:
- Use guaranteed annuities for must-haves - i.e. expenses like medical aid, food and household expenses.
- Use living annuities for nice-to-haves like holidays or a new car, and for long-term emergencies such as age-based illnesses.
- Use discretionary (non-retirement fund) investments for short-term expenses and emergencies.
- Make sure that the investment portfolio is focused on beating inflation by a comfortable margin over time. A personal investment target of 3% to 5% above inflation is usually ideal.
- Reduce investments' volatility by choosing asset classes, managers and smoothing solutions that minimize the chances of large negative returns.
- Use dynamic withdrawal strategies, e.g.• Don't increase withdrawals after a negative year.
• Defer ad hoc expenses (e.g. travel, a new car) after a negative year.
• Select a 10% real "raise" only if capital reaches 150% of the initial investment.
Everybody's circumstances are different and having a relationship of trust and understanding with a financial planner could make a big difference. To set up a strategy that is focused on your specific needs and circumstances, speak to your financial planner. Although it costs money in the short term, the benefit of a sound financial strategy will pay for itself many times over in the long run.
Download the Winter 2019 newsletter