Most retirees share the same goal: Saving enough capital to last the rest of their lives.
Retiring from a retirement annuity or pension fund allows you to take a third of your capital in cash. You are legally required to purchase an annuity with the balance of your savings.
A provident fund generally allows you to take the entire sum in cash, but this depends on the rules of the fund. This allows you to invest this lump sum as you please.
Investors tend to think one must choose between a living vs guaranteed annuity, but you can actually use both products to offset the key risks many retirees face. Namely, outliving you savings and the risk of inflation degrading the purchasing power of you money over time.
Guaranteed life annuity
This annuity pays a pre-determined income for the rest of your life. This covers you from outliving your money. Your rate is influenced by age and the current interest rate. A shorter life expectancy implies a higher income.
This security comes at a price: Your beneficiaries have no claim to your money after you die, since the insurers take control of your capital. You can protect your family against this by making use of an initial guarantee period, which allows them to claim if you die before the period has expired. Selecting this option will, however, give you a lower retirement income.
There are various versions of the guaranteed life annuity and it’s advisable to shop around for one that best suits your needs. Make sure you understand the effect inflation will have on the various products, since it can seriously erode your money’s buying power and your ability to maintain your standard of living.
Once you buy this product the terms are set for the rest of your life. If you require a bit more flexibility then you should consider a living annuity.
The income from a living annuity is not fixed and is thus also known as a linked annuity since performance is linked to underlying investments. It gives investors more flexibility, but also more risk. Market and longevity risk are of particular importance. It’s advisable to consult a financial adviser when using this option.
Asset allocation will be your first big decision. Important things to consider include what kind of growth you require to sustain your investment and the risks you are willing to take. It is best to consider assets, which show potential for long-term growth.
Asset classes that show potential for high returns also tend to be quite risky and volatile over the short term. Thus, if you want a higher income you will have to weather the risks involved and ensure you have the best performing unit trusts in your portfolio.
Deciding how much to draw is the next big step. Legislation stipulates you can draw between 2.5% and 17.5%. You are able to change your income level once a year and it is important to remember to keep sustainability in mind. There are a number of unknowns at this point like the real return of the investment, the effect of inflation and your life expectancy. Offset these unknowns by making rational assumptions, withdrawing a reasonable income and adjusting when the plans need to change.
Asset allocation and your withdrawal rate influence the longevity of your investment and your standard of living post retirement.
A hybrid approach
Retirement is not the end of your investment cycle. You can use this time to generate investment returns, while drawing an income. Thus it makes sense to combine living and guaranteed annuities.
Insurers will offer you better value, as you get older since your risk profile is linked to those of your peers. As the mortality rate of the group increases so does the income offered. Thus one can start with a living annuity and transfer to the guaranteed annuity when the income levels on offer increases. This gives you flexibility and, eventually, security.
If you prefer security from the outset then consider dividing your retirement savings at retirement. You can invest in both living and guaranteed annuities with the option of transferring the entire investment to a guaranteed annuity later on. You are allowed to transfer from a living to a guaranteed annuity, but not the other way around.
We can easily spend as much time in retirement as we did working. It is thus important to realize that retirement is the start of the next phase of financial planning and not the end of it.
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