Corospondent - April 2019
The choices you will face at retirement - April 2019
AN EARLIER COROSPONDENT article, ‘The numbers that drive retirement’ provided some guidance on how to plan as efficiently as possible for your retirement to avoid being caught unawares. Equally important is understanding the choices you will face at the point of retirement.
Because you are likely to save towards your retirement nest egg over multiple decades, by the time you retire it may well be the single biggest asset on your balance sheet. What you end up doing with this pot of money is one of the most critical financial decisions of your life, as your decisions will determine your lifestyle for the next 25 to 30 years.
YOUR TWO CHOICES AND WHAT YOU NEED TO KNOW TO MAKE THEM
If you are close to retirement, you will soon need to make two decisions about the savings that you have accumulated over your lifetime. As both require careful thought, it may be best to make them with the help of an independent financial adviser (IFA).
To make this process a bit easier to navigate, we have outlined some of the considerations:
1. Do I take a cash lump sum from my savings? If so, how much should I take?
Before deciding on the amount of cash you wish to take as a lump sum, you need to determine its purpose (such as settling any outstanding debt at retirement, funding a holiday or setting up an emergency fund) and whether you can afford it. As a general rule, funding capital transactions such as acquiring an asset or settling debt is preferable to funding current expenditure. It is important to keep in mind that any cash amount withdrawn leaves you with less capital to purchase an annuity from which you will be drawing your retirement income..
A useful exercise to conduct with the help of your IFA is to map out liquidity scenarios over at least 20 to 30 years, based on your personal circumstances.
Importantly, the amount of money that you can take in the form of a cash lumpsum is determined by the pension fund of which you are a member:
Tax is another important factor to take into consideration. The good news is that the first R500 000 taken as a cash lumpsum is tax free. If you wish to withdraw an amount greater than that, the following tax rates apply:
2. Where do I invest the rest?
Whether or not you choose to take a portion of your retirement savings in cash, the balance of your investment must be used to purchase an annuity that will pay you a retirement income for the rest of your life.
Retirement savers currently have two main options from which to draw their post-retirement income: a living (market-linked) annuity or a guaranteed (life) annuity underwritten by a life insurance company. Both products have their own set of advantages and limitations. One of the biggest differences is that in the case of a guaranteed annuity, your income is guaranteed for life, while a living annuity offers no income guarantee but greater flexibility and the potential for capital growth. The following table outlines some of the key differences between the two products.
Many investors choose to transfer their retirement savings to a living annuity (as opposed to a guaranteed annuity), as it comes with various advantages (as tabled above). However, choosing the living annuity as your retirement income vehicle comes with the most challenging of investor needs: balancing the needs of today (drawing an income) with those of the future (achieving long-term growth).
To ensure that you can sustainably draw a certain level of income throughout your retirement years requires you to invest in an appropriately constructed portfolio and then to select a conservative income rate early in retirement. Drawing too high an income at the start of your retirement and/or expecting too high an investment rate of return is as dangerous as investing too conservatively or too aggressively.
Once your living annuity plan is in action, you should carefully moderate the amount of retirement income you draw in response to the performance of your underlying investment. By applying a few spending rules with assistance of your IFA, such as dynamically adjusting your income drawdown rate in response to returns, retirees can ensure capital preservation; in other words, first earn the returns before spending them.
MAKING THE MOST OF YOUR LIVING ANNUITY
- Select a conservative income rate early in retirement: The rule of thumb is an initial drawdown rate of 5% or less. This increases the probability that your underlying investment portfolio will grow and sustain its ability to protect the purchasing power of your retirement income over time.
- Invest in an appropriately constructed portfolio: To grow your income so that you keep up with inflation over the course of 25 to 30 years, your capital needs to grow too. Given that you still have a multi-decade time horizon over which you need inflation-beating returns, you require a diversified portfolio that has meaningful exposure to growth assets such as equities and property.
Investors early in retirement should seek funds that allow at least 50% of the portfolio to be invested in growth assets. But your living annuity’s underlying investment fund also needs a strong focus on risk and reducing the likelihood of potential negative returns over shorter time periods – this is important because you will be drawing a regular income from the fund.
GOOD NEWS FOR THOSE INVESTORS STILL BATTLING TO MAKE A CHOICE
As of 1 March 2019, investors who still grapple with choosing between a living and a guaranteed annuity can consider investing in the annuity option pre-selected by their retirement fund trustees. This follows an amendment to the Pension Funds Act which requires trustees of pension funds to select an annuity strategy with the highest chance of providing a sustainable income throughout a member’s retirement.
The Coronation Trustee Selection
If you are a member of a Coronation retirement fund, the trustees have selected the Coronation Living Annuity as its annuity option and Coronation Capital Plus Fund as its underlying investment portfolio. You can read more about why Coronation Capital Plus is a suitable investment option in the text box below.
If you wish to select the Trustee option, you will be required to ‘opt in’ by way of documentation that will be sent to you ahead of your retirement date. By choosing this option, you also accept the maximum income withdrawal rates as outlined in the table below. The income rate you will receive is determined by the value of the investment you use to purchase the annuity, as well as by your gender and age at the point of retiring from your Coronation retirement fund.
What if this option no longer suits my needs?
If you prefer to invest in another Coronation fund/s as your underlying investment option, you can switch to your own selection at any time. You can also select a higher income rate on your annual annuity anniversary date. By switching funds or changing your income rate, you are ‘opting out’ of the trustees’ selection and you will simply be invested in a standard Coronation Living Annuity. Should you wish to transfer to an annuity option offered by another company, this can also be done at any time.
Why Coronation Capital Plus?
Coronation Capital Plus is our flagship living annuity portfolio. The fund is designed and managed specifically for the retired investor who needs to draw an income from their investment over multiple decades. Capital Plus therefore invests in a reasonable amount of growth assets – typically ranging between 40% and 70% of the portfolio – to achieve returns ahead of inflation. However, given that investors also need to be drawing a regular income from the fund, Capital Plus has a strong focus on risk and potential negative returns over shorter time periods. The fund is therefore managed to ensure no negative returns over any rolling 18-month period – which Coronation has achieved over 97% of its history.
Since its inception in 2001, this approach has worked well, with Capital Plus having produced a nominal after-fees return of 11.8% per annum (or 5.9% per annum in real terms) as at end-March 2019. Over its history, the fund has also achieved a positive rolling 18-month return 97% of the time (with the only negative rolling 18-month return period coinciding with the financial crisis of 2008).
The graph below demonstrates how, in the fullness of time, the benefit of having reasonable exposure to growth assets becomes clear for income-drawing investors. Let us assume you retired in July 2001 when the Coronation Capital Plus Fund was launched and invested R1 million worth of retirement savings into the fund through your living annuity. If you started to draw 5% per year and allowed your annual income to increase in line with inflation of roughly 6% per year, you would have withdrawn a cumulative R1.5 million rand over the almost 18-year period as income – an amount that is greater than your initial investment amount of R1 million. However, by investing in Capital Plus, your initial investment would have grown to almost R3.9 million.
To read more about post-retirement investing, download the September 2018 issue of Corolab, The Income and Growth Challenge