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How long will your retirement capital last?

Reader’s question answered.

CAPE TOWN – In this advice column Mark Lapedus from Liberty Investments answers a question from a reader whose parents need to generate income from their savings.

Q: My father, who is 64 years old, became very sick and according to doctors will probably live only another five years. My mother, who is 63, now needs advice on where or how to invest R2 million.

They need to receive a monthly income of about R25 000 to meet all their living expenses. They also needs to earn some growth for future unforeseen expenses like health care. What should they do?

Unfortunately the first part of the response to your question is that your parents need to moderate their expectations, perhaps substantially. To earn a monthly income of R25 000 off R2 million is going to be very difficult, if not impossible. That is not even considering the need to set some money aside for unforeseen expenses.

We don’t have details on whether the R2 million is the only asset that your parents have, or if they own other assets from which they can draw down. However, a monthly draw of R25 000 equates to R300 000 per annum, which is 15% of the capital.

Usually a 4% draw-down is considered prudent if you need the capital to last for a long period of time. So 15% is a very high ratio at which to draw and if investment returns don’t match this, then the capital can decrease quickly in nominal terms.

If they were to take R25 000 as a monthly income, that capital earned 8% per annum and they increased their income by 5% every year to allow for inflation, the R2 million would last only seven and a half years.

This is even assuming that the R2 million is in after-tax assets, and so tax is only payable on the income and growth going forward and not on any income drawn on a monthly basis.

Your father may only live for another five years, but if your mother is in good health then she could live longer than this and will need money to live off for a lot longer than seven years.

As mentioned earlier, it is possible that they have other assets or maybe your father has life insurance which could mean more capital upon his passing. However, if this is not the case, then there will be a problem when the money runs out.

In order to extend the time for which the money lasts, it would be best to reduce the amount drawn monthly by cutting back on expenses. They may also need to supplement their income from other sources, such as family or some form of employment.

An alternative would be to take on more risk with the investment to generate a higher return, but this could be difficult to achieve and may not be wise if it is all the money they have. In order for the capital to last for 15 years, which would be until your mother is 78, the return after tax and costs would need to be 16.5%.

A typical balanced portfolio in South Africa has probably earned an average return of 13% to 15% per annum over the past ten years. This has been in an unusually strong market run.

We know that historical returns are not an indication of future returns and we don’t know what future returns will be. However, most fund managers and economists in South Africa are telling us to expect lower returns over the next five to ten years than we have in the recent past. If we assume this to be correct, then the likelihood of achieving 16.5% per annum return is low.

I would recommend that your parents consult with a financial adviser who can look at the full picture and give more detailed recommendations on how the money should be invested. This will address the maximum amount which should be drawn, and which investment products are most appropriate taking into account the access to money every month.

It may also be prudent for them to set up an access fund held in a money market account or a similar liquid, low volatility investment which they can use as necessary. However, that would lower the available capital, and thus the potential monthly income they could earn off it even further. The adviser will be able to give recommendations in this regard.

Mark Lapedus is at the head of product development at Liberty Investments.

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