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If you’ve worked hard your whole life and are currently getting ready to trade your work clothes and coffee mug for a Hawaiian shirt and a pina colada, you might be feeling slightly anxious. Justifiably so: approaching retirement can be exciting but also unnerving, and soon-to-be-retirees have much to think about. Andre Tuck, Investment Consultant Team Lead at retirement specialist 10X Investments answers a few common questions on income products, drawdowns, budgets and tax to hopefully give you more peace of mind.
What are my investment income options?
Before retirement, it was up to you to build a savings pot to finance the lifestyle you wanted in retirement. After you retire, you are obliged by law to use at least two thirds of your retirement savings to buy an annuity, which will pay you an income in retirement. There are two types of annuities you can choose from: a guaranteed annuity (also known as life annuity) or a living annuity.
What's the difference between a living annuity and a guaranteed annuity?
A guaranteed (or life) annuity is an insurance-type product, where the insurer pays you a specified amount every month for the rest of your life.
While this insures you against longevity risk (the risk of outliving your savings), it comes with a few limitations. These include not having any control over how your money is invested and not having the flexibility to draw a lower or higher income. This can be inconvenient should your expenses change, or if you wanted to spoil yourself with, say, an overseas trip. Another downside is that in most cases your policy dies with you, and even though you may be able to make provision for your spouse, no money passes to your heirs.
A living annuity, on the other hand, is an investment-type product that transfers the risk and responsibility for securing a sustainable income to you. This gives you more control (and responsibility), with greater investment and income flexibility. Plus, your heirs will inherit whatever is left of your capital after your death.
How do I know which annuity is best for me?
These products address different needs. Therefore, this decision requires careful evaluation of your personal circumstances and plans for your retirement. There are a host of factors to consider, for example your health, age, desired income, how much you have saved and the needs of a financially dependent spouse. You will also need to think about whether you prefer a secure or flexible income and whether you want to leave something for your heirs. It’s important to do your research and speak to a retirement expert to get the facts that will help you make the decision that’s best for you.
Can I switch at a later stage?
Legislation allows you to switch from a living annuity to a guaranteed annuity, but not the other way around. Once you have signed up for a guaranteed annuity there is no going back.
How much income will I need to retire comfortably?
During your working life, you will probably have saved toward a specific number; your savings goal. Now that you are approaching retirement you will have a better sense of what your lifestyle costs are, and can therefore be more precise about what you will need.
A carefully thought-through budget is always the best place to start. And what better time to refine your budget than as you reflect on the past year and look toward a new one.
Here are a few things to think about:
How will my income be taxed?
The income you receive from your annuity (living or guaranteed) will be taxed according to the prevailing personal income tax table.
How much income would I be able to draw from a living annuity?
By law, you must draw between 2.5% and 17.5% of your investment value. Generally, around 4% to 5% is thought to be sustainable, although that isn’t guaranteed. To help you work out a sustainable income (drawdown) to ensure that your savings last your retirement years, you should consult a planning tool such as the 10X Living Annuity calculator or speak to a retirement expert.
What will my annuity cost?
Few retirees realise that the fees on their living annuity are often their single biggest expense in retirement – bigger even than medical aid. Because fee percentages look like small numbers and are deducted from your investment rather than being directly debited from your bank account, retirees often have no idea what they are paying and aren’t motivated to find out. But, you should always get your Effective Annual Cost from your provider or advisor, and understand your living annuity fees as a rand value, not just a percentage. Also, you should consider that switching to a low-cost provider could potentially boost your financial position significantly, without compromising your lifestyle.
Assuming a living annuity drawdown of 5% from a R4.8 million pension pot, a retiree would receive a pre-tax income of R240 000 per annum or R20 000 per month. If fees were in the region of 3% per annum – usually made up of advice, administration and investment management fees – retirees would be paying costs of around R144 000 per annum (R12 000 per month). Which means, almost 60% of the drawdown goes on fees! This example assumes an ‘everything else being equal’ methodology, and real results may vary.
Moving to a low-cost living annuity provider such as 10X, that charges less than 1% per annum in fees, you could potentially draw R28 000 a month and pay fees of R4000 per month. You can do a free cost comparison with 10X if you’d like to explore your fee situation in more detail.
However, drawing down at 7% per annum could deplete your savings quite quickly. It might be more prudent to keep your income unchanged and let the 2% per annum saving compound within your living annuity. Depending on your choice of portfolio and future market returns, this could add five to fifteen years to the sustainability of your income. To bring this to life you can work out your own numbers using the 10X Living Annuity calculator.
Whether you have been retired for many years or are about to embark on this next chapter of your life, have a look at your numbers and make sure you’ve made the right provisions for your future.
The content herein is provided as general information. It is not intended as nor does it constitute financial, tax, legal, investment, or other advice. 10X Investments is an authorised FSP # 28250. The 10X Living Annuity is underwritten by Guardrisk Life Ltd.