By Gerard Visser, Alexander Forbes Financial Planning Consultant
As you approach retirement, one needs to decide the age you would like to retire at. More importantly, whether you can in fact retire with the available funds you have and if the income you will receive will sustain you for the rest of your life.
Before deciding to pay yourself an income at retirement, new legislation allows members who are part of an employer’s pension or provident fund to postpone their retirement, even though they have reached the normal retirement age of the fund. But why would you want to defer your retirement? You could have a part time job or contract work lined up for a couple of years and not need to make use of your funds yet or you might not have enough funds saved and need to defer in order to be able to retire more comfortably at a later age.
Once you have decided to start earning an income with your retirement funds, you have two options when it comes down to paying yourself an income at retirement – invest into a living annuity and make a drawdown or purchase a life annuity/fixed annuity.
A life annuity and living annuity might sound similar but they are completely different options and you need to make sure you understand both the available options and implications of your choice. You can move your funds from a living annuity to a life annuity but not the other way around, so once in a life annuity you cannot change your mind.
A living annuity gives you flexibility with regards to the income you can pay yourself, you have to choose a drawdown between 2.5% – 17.5% per year and most clients choose to be paid this income monthly. You need to set up portfolios with your financial advisor where the money for the living annuity will be invested. It is important to set the portfolios up correctly and according to your specific need as all investors differ; some enjoy conservative investments while others will still try to grow the capital as retirement is over a long term. You have to consider the sustainability of a living annuity and try stick to the recommended drawdowns as this not only has market risk (volatility of the markets) but the investor runs the risk of outliving their investment or depleting their capital which in turn has a direct impact on the amount of income you can pay yourself. Investing into a living annuity is the most flexible investment option when considering the two, as you can also change your income drawdown once a year. You can nominate beneficiaries for a living annuity, allowing legacy for the remaining capital in the investment.
Your second option would be to consider a life annuity/fixed annuity. Many clients are under the incorrect impression that this is a product no longer in use. However, life annuities are perfect for clients looking to guarantee their income for the rest of their lives. You have an agreement with an insurance company to “swop” your capital for monthly income payments the rest of your life. If you are married, your spouse would receive an income after your death. When receiving the quotes, you need to decide whether you would like a single or joint life annuity. A single life annuity only pays for as long as you live, while a joint life annuity will pay until the death of your spouse, so if either of you die the other will still receive an income. There is no longevity with life annuities, meaning that upon your death the insurance company retains the capital.
How can I ensure longevity or legacy to my heirs? To avoid losing out and having an insurer keep all your retirement savings, you can add guarantee terms to the life annuities. Guarantee terms protect you in the event of early death. If you added a guarantee term of 15 years and passed away at year five, your beneficiaries are still able to receive 10 more years of the fixed annuities income.
Life companies will offer variations of these different life annuities and these vary from company to company so it is worth finding out how they differ and exactly what you are buying. You typically get the following types of fixed annuities: inflation linked annuity, fixed increase annuity, with profit annuity and a level annuity. The initial starting monthly income as well as future increases differ with all of them.
Do not assume what you are currently putting away for retirement will be enough, visit a certified financial adviser and do the calculations to see where you stand. Do not wait till the last minute because saving and having enough money for retirement is your responsibility.