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Pension investment options

I’m a 61-year-old widower and plan to retire at the end of this year. My current pension value is R4 122 906.10. If I invest my money in a living annuity and require R20 000 per month, how long will my money last?

Q:I’m a 61-year-old widower and plan to retire at the end of this year. My current pension value is R4 122 906.10. If I invest my money in a living annuity and require R20 000 per month, how long will my money last?

Sonia du Plessis - Brenthurst Wealth

Thank you for your question. Please note as we haven’t done a full needs analysis the advice I can offer will deal specifically with an income requirement of R20 000 monthly and will not take into account the need for any other ad hoc withdrawals. Ideally other assets, liabilities, other sources of income and access to any lump sums are some of the questions which should also be taken into account in order to answer your question holistically. Your tolerance towards risk, your short- and long-term goals, any family members dependent on you, are also important personal circumstances which should be taken into consideration. These combined factors will determine the risk most appropriate for your personal circumstances and ultimately determine the portfolio construction for your living annuity.

Once an appropriate level of risk has been determined the investment portfolio constructed on your behalf should reflect this level of risk. The performance of your living annuity will therefore be linked to the appropriate level of risk and your personal needs which is the income you require.

As you are now 61 years old, which is considered young due to increased longevity, and with the limited information provided, I have assumed that you have no liabilities or dependents and as such would be able to take on a moderate degree of risk.

If you do not have any other sources of discretionary capital you may need to consider withdrawing a lump sum to give you some liquidity and transfer the balance to a living annuity to draw your income.

At retirement of your pension you should be able to draw 1/3 as a lump sum of which up to a maximum of R500 000 could be tax free as long as you have not withdrawn any lump sums from retirement funding previously.

Any lump sum amount over and above R500 000 will have tax consequences. However for the purpose of your query we will assume that you have adequate discretionary funding and will be transferring the full amount to a living annuity.

If I assume that you require R20 000 before tax, you would net R17 444 monthly and pay approximately +/-R2 556 in income tax. Using R240 000 per annum on an asset base of R4 122 000, is an income percentage of 5.8%. With inflation currently over 6% and considering your young age you need to grow your capital above inflation and after withdrawal. This means you would need to achieve a growth rate of more than 11% per annum. This has become particularly difficult in the current low-growth environment. As a general rule of thumb we suggest an income withdrawal of 5% or below, but in the current economic environment below 5% would be preferable.

This will ensure you preserve your capital in a lower-return environment and grow your capital over and above your withdrawal level. Rising inflation however remains a concern in a low-return environment, but over longer periods historical returns have beaten inflation which should be monitored on an ongoing basis. Assuming a worst case scenario of 6% growth and 4% withdrawal increase per year, your funds will most likely last 20-25 years – then the capital will be depleted. Markets will however improve at some point as they move in cycles which should result in better returns in future years, which will improve your cashflow projection of your portfolio. We suggest this is monitored on at least an annual basis.

The other alternative, especially if this is your only source of retirement capital would be to consider a traditional or life annuity whereby you will receive a guaranteed income for the remainder of your lifetime which can accommodate inflationary or annual increases. It is worthwhile receiving quotes for a traditional life annuity and to compare this to the risks and benefits of a living annuity and determine which is more suitable for your personal circumstances.

As there are many factors to consider I would strongly suggest you contact a financial planner, who can review your personal circumstances holistically and provide you with all of the above options to make an informed decision. You’ve worked very hard to build up this capital, and want to make sure your capital will provide an income for the remainder of your lifetime. You also need to be fully aware of the benefits and restrictions of both a living annuity and traditional life annuity and which product will be more beneficial for you. It is very important to review your financial plan every year with your financial planner to ensure any circumstantial changes are taken into consideration and to ensure you will have sufficient funding for the remainder of your lifetime.

All the best, I wish you a successful retirement.

COMMENTS   5

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Good answer with the limited information available.

I find the response to be unhelpful. This client will be able to secure a guaranteed income for life of around R22 900 which targets growth in line with inflation and a guarantee period of 15 years which means that he gets his money back even if he died early in retirement. This should be the minimum income the pensioner should be drawing comfortably as it has no risk (he can never run out of money and his income can never reduce – some residual risk if increases do not match inflation each year). Pensioners should only consider taking on theses risks in a living annuity if they can expect to be rewarded for it by way of higher income. Most people in living annuities run a significant risk of outliving their assets and even more pensioners run the (significantly higher) risk of hitting the drawdown cap of 17,5% in a living annuity after which their income will reduce in nominal terms! If this member draws R20000 per month and increase it annually with inflation, and the underlying investment strategy provides a decent return for each future year (with no downside suprises), the member is likely to hit the cap by the age of 78-80. After that the member’s income will reduce each year due to the design of living annuities i.e. they cannot get their hands on the money no matter how destitute they have become. The money will only be available to their beneficiaries on death. For this reason, ASISA and advisers in general, want clients to draw as little as possible to avoid that happening. What seems to be sensible and good “advice”, is actually causing the pensioners in our country to UNDER-consume. This client is in a healthy financial situation relative to his income requirements, but most pensioners have not even saved enough to begin with. Then 90% of pensioners go into living annuities as they cannot live off the income from guaranteed annuities (this is a sign that you have not saved enough!), hoping to make up for it through high future investment return. They should rather try to defer retirement as their ability to earn an income for another year or two is not totally zero. But once you’ve been retired for a couple of years, it is often too late to make a come back. Encourage our senior citizens to work for longer if they dont have enough. A very powerful framework being deployed by advisers is to construct a combination of a living annuity and a guaranteed annuity. Research has proven that any mix will provide a better outcome than any of the products on a stand alone basis. That is useful information that should form part of any discussion an adviser is having with a pensioner to help them make the most of their retirement. “Advising” them to draw as little as possible is not adding any value.

Forget about all the smoke and mirrors above.
Resign from your job 2 months before you are forced to hand your money over to the financial “experts”. Pay the tax due and you will be left with +/- R2 700 000.00
Invest R 240 000.00 in the 1st year into a savings account and R 240 000.00 amounts into fixed deposits for 12/24 and 36 months to give you the R 20 000.00 per month for the 1st 4 years. This money will earn you +/- 7 to 9 %. So the fixed deposits will grow by +/- R 19 000.00 per annumper R240 000.00 amount
.
This leaves you with R 1 980 00000 which you invest in a 4 year fixed deposit where you can earn in excess of 10 % annualy. (Capitec/ Ned etc)
You then earn +/- R 202 950.00 per annum in interest.
You pay the tax on your interest but your money keeps growing, not diminishing from the time you give it over to the “experts”.
After the 1st 4 years you have +/- R 2.6 M and you do the dame thing over.

I don’t know what is more concerning. The response by sucker or the fact that it received 7 likes! Do the math quickly to see how long this strategy will last if the person draws say R17,5k per month (as this is now the after tax income requirement) and it increases every year by 6% to account for inflation. Assume further that you will be able to earn 10% per annum forever. If your answer is close to 16 years, I think you just got lucky. Now ask yourself if this is a brilliant outcome if the average life expectancy for a 61yr old male is 18years. You could not possibly have given a worse suggestion, and that ignores the fact that we are around the top of the interest rate cycle, so the 10% assumption for future interest rates is on the overly-optimistic side. It saddens me when I see these type of comments as it shows two things (1) low levels of trust between the general public and the financial institutions and (2) the low level of understanding of retirement matters especially the risk of outliving your assets.

End of comments.

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