10 tips to retire in Paradise
 In this article, Karen de Kock-Wentzel, Head of Annuities at Sanlam Structured Solutions, shares with you 10 tips that can lead to a happier and more financially secure retirement.
Retirement is referred to as your ‘golden years’. The latest statistics show that people all over the world are living longer. On average a male aged 60 will live for another 18 years and a female aged 60 will live another 21 years. This is good news, because, with your ‘golden years’ being longer, you will be able to spend more time with your children and
grandchildren, or even travel. However, the harsh reality many people encounter is that they have not saved enough money to carry them through their extended ‘golden years’. The result is that many people have to return to work, downgrade their standard of living or rely on family to enable them to survive!
10 tips to retire in Paradise
1 Personal responsibility
A few years ago, defined benefit plans were the norm and the preferred way in which employees received promised benefits with a guarantee for life. The benefits were determined based on their final salary and number of years on service and employees did not carry any risks. The risk of living longer than expected or earning lower than expected investment returns, for example, were carried by the employer. During the last 10 years, there has been a shift from defined benefit to defined contribution schemes, with employees carrying all the investment risk.
Defined contribution schemes offer a variety of choices to members who now have to choose between a range of investment products and providers. When reaching retirement
age, members are also responsible for buying their own retirement income (pensions) in the form of an annuity. The type of annuity chosen will determine the risks a member will take in retirement.
However, with choice comes responsibility. Retirement planning and retirement risks are an employee’s personal responsibility and members should plan well in advance to ensure financial comfort in their golden years.
2 Past and present
In the good old days you would probably have been a member of a defined benefit fund and spent your entire working career with the same employer, which would have enabled you to achieve the income level of 75% of the income you were earning before retirement. But times have changed!
People now start working later, retire earlier, live longer, and are generally members of a defined contribution fund. People also tend to change jobs more frequently and often do not preserve their retirement savings. The result is that people are not saving enough and statistics show that only 6% of South Africans can afford to retire.
3 Pension plans available at retirement
Thousands of South Africans face one of the most important financial decisions of their lives when choosing the type of pension that best suits their needs. Various options are available from a large number of insurance companies. During their working careers, members accumulate their savings to provide for retirement. Most advice and education given to members focuses on building wealth ahead of retirement. It is very natural that this is given more priority. However, little or no focus is placed on what to do with a retirement lump sum after retirement. At retirement, the accumulated savings are used to buy one of the following annuity (pension) products:
A guaranteed escalation annuity
These annuities provide the pensioner with a pension that increases at a fixed rate over the remainder of his or her life. The initial pension and future increases are guaranteed for life.
A level annuity
A level annuity is a guaranteed escalation annuity with a 0% increase and makes no provision for annual increases. This annuity will provide the highest initial pension, but pension payments will stay level and not keep up with the increase in the cost of living.
An inflation-linked annuity (CPI annuity)
The inflation-linked annuity provides a guaranteed monthly pension with annual increases equal to inflation. This increase will be equal to the Consumer Price Index (CPI), lagged by four months. Inflation-linked annuities address the need to protect the pensioner’s purchasing power. By selecting an inflation-linked annuity, pensioners do not carry any longevity or investment risk, as initial pensions and increases are guaranteed for life and pensioners are guaranteed to receive annual pension increases at 100% of CPI inflation. Even if CPI inflation is negative, pensions will not decrease.
A with-profit annuity
A with-profit annuity provides a guaranteed income for life with some investment participation in the form of increases to the pensioner via annual bonus declarations. The
bonuses are derived from the return in the underlying portfolio, typically a balanced fund, after allowing for mortality, smoothing, the purchase rate and costs. The bonus declaration to determine the increases are subjective, and takes into account numerous factors, as mentioned above. By choosing a guaranteed escalation annuity, an inflation-linked annuity or a with-profit annuity, the longevity and investment risks are carried by the insurance company. Pensioners will receive a guaranteed monthly income for the duration of their lifetime.
A living annuity (ILLA)
A living annuity is a financial product in exchange for investing a cash lump sum (usually a payment payout from a pension fund, a provident fund or a retirement annuity). The investor receives a monthly pension for as long as there is money available in the fund. The most attractive features of living annuities are the flexibility in withdrawal rate and investment choice, together with the advantage that the remaining capital at death is paid to the investor’s estate. The investor can also select the annual rate of withdrawals from a living annuity. The minimum annual withdrawal allowed is 2,5% of remaining capital and a maximum withdrawal of 17,5% of remaining capital. An ILLA provides the investor with a greater degree of freedom in managing his or her investments, as a high degree of choice is allowed in selecting the underlying asset mix. The remaining capital in a living annuity is not lost in the event of death after retirement, and can be paid
out to nominated beneficiaries. This is a particularly attractive feature for retirees suffering from poor health.
Despite all these attractive features, investors must consider the impact of longevity and investment choice when choosing an ILLA. People who live longer than average are highly exposed to the risk of running out of cash. While it is attractive to enjoy the facility of managing one’s own investments post-retirement, this does place a great
burden of responsibility on the investor. There are no guarantees, so a general decline in the market will reduce the investor’s funds and the impact on future pension amounts.
Each of these annuity options has advantages and disadvantages. It is important that pensioners are aware of the consequences of the risks associated with each option.
The three most important decisions that a pensioner must make in choosing an annuity are:
- What level of initial pension do I require?
- What type of future annual increases do I prefer?
- What type of risks am I prepared to take?
However, one type of annuity is not better than another and there is no standard solution in retirement.
You must consider your personal circumstances and needs at different times in your life. Consider the different options and ensure that your hard earned savings last a lifetime.
4 Preserve your savings (i.e. don’t touch your retirement savings)
The current trend is that people in their 20s (Generation Y’ers) have a reputation for job-hopping. When leaving a job, many people will cash in their retirement savings and pay the tax penalty. Nobody likes the idea of putting money away for a rainy day sometime in the future. Withdrawing your savings two or three times as a young employee during your working career results in a large amount of your retirement savings being depleted.
Make sure you preserve your benefits when you change jobs by transferring your benefits to your new retirement fund or to a preservation fund. Spending instead of preserving retirement fund benefits is one of the biggest reasons for inadequate retirement provision.
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