Making Your Income Last Through Retirement

A very small percentage of South Africans are able to retire comfortably. Planning is essential to ensure you have sufficient funds to last the rest of your life. The consequences of your decisions can sometimes only begin to appear a few years into your retirement. It is therefore important to assess your financial position and retirement needs as early as possible. Here are five of the most important decisions you should consider when planning for retirement.

Living or guaranteed life annuity?

Retirees face two major risks when considering their finances, namely outliving their savings or the erosion of their money’s buying power due to inflation. Both guaranteed life and living annuities can help to combat these risks and some circumstances may call for a combination of both.

A guaranteed life annuity pays you a pre-determined sum for as long as you live, thus protecting you against the risk of outliving your savings. The sum you receive is influenced by the current interest rate and your age, with higher incomes linked to shorter life expectancies. Once you purchase a guaranteed life annuity you cannot leave the money to a beneficiary or transfer it to a living annuity.

There are many benefits to guaranteed life annuities. They protect you against overspending during the early years, remove the risk associated with poor investment choices and insure against outliving your capital. However, guaranteed life annuities are highly inflexible and the terms are set for life.

You generally receive more flexibility with living annuities. You are allowed to choose your underlying investments and determine your own income rate. You could take a smaller sum now and grow your capital for later in life, or leave capital to your beneficiaries. This flexibility however, comes with longevity and market risk.

How to choose an appropriate draw down rate?

Investing in a living annuity requires you to define the level of income you could live on. This is known as the ‘draw down rate’. The draw down rate has a legally defined range of 2.5% to 17.5%. Research conducted by William Bengen, a US financial advisor, suggests a draw down rate of 4% in your first year of retirement. Bengen goes on to suggest increasing or decreasing your withdrawal’s absolute cash value each year by inflation.

Many retirees fail to save enough money and therefore 4% of their savings might not be enough to retire comfortably. Every person has unique goals and needs. The best thing to do is seek out the advice of an independent financial advisor.

 

How should you allocate your assets?

Asset allocation is of particular importance with living annuities. Careful asset allocation ensures that your investment continues to grow even as you draw an income.

Bengen’s research suggests a 50% allocation to equities. Longer lifespans can mean retirees should avoid being too conservative and rather position their portfolios for growth.

How should you account for inflation?

Accounting for inflation is essential to ensuring your capital lasts. This means protecting your capital’s buying power. If you assume an inflation rate of 5% and a draw down rate of 4%, then you require a minimum rate of return of 9%. A return rate of less than 9% effectively loses you money.

In reality, a large portion of your total return on investment has to compensate for inflation before returning any real earnings. Underestimating the negative effects of inflation on your capital could lead to the erosion of the supposedly secure fixed interest return you receive on cash and bonds.

Should your draw down rate be increased annually?

Bengen concludes that one can enjoy an income for at least thirty years if you follow the 50% asset allocation, 4% draw down and inflation adjustment guidelines. These guidelines proved sustainable in nearly every scenario, while a draw down rate of 5% would not last thirty years in a third of the cases investigated. Annual rebalancing and inflation adjustment are essential to holding the 4% rule.

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