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Choosing the right plan for your retirement

29 September 2014 Tracy Jensen, 10X Investments
Tracy Jensen, Product Architect at 10X Investments.

Tracy Jensen, Product Architect at 10X Investments.

The difference between a living annuity and guaranteed annuity.

Saving for retirement is only one step towards ensuring that your golden years are enjoyed, without having to compromise your living standards. Without proper planning and an appropriate investment strategy, South Africans can put themselves at risk of running out of their savings during their retirement.

This is according to Tracy Jensen, Product Architect at 10X Investments (10X), who says that it is essential for all South Africans to start seeing planning for their retirement as two-tiered approach: pre- and post-retirement. "Even though many people understand the value and importance of saving for their retirement, they often don't understand that this is only the first step to ensuring that they have enough income to carry them through their retirement years."

She adds that as much as investors focus on saving for their retirement, so investors should begin considering their retirement options and goals about five years before retirement.

Jensen strongly recommends that those approaching retirement make sure that they carefully consider all options available that will provide them with a retirement income. "Two of the most popular choices are a guaranteed annuity and a living annuity. Before selecting an annuity, however, it is important that investors look at the pros and cons of each option to determine what will meet their particular retirement goals."

The difference between a guaranteed annuity and a living annuity is that a guaranteed annuity will provide an income that is guaranteed to last for the investors whole life (and the investors spouse's, if applicable), but the investors heirs won't be able to inherit whatever is left on their death. In other words, the capital dies with the investor.

"Typically, you also have no say over your initial income and no flexibility to change your income or to move to another annuity or service providers once you've purchased the product," points out Jensen. "There are various types of guaranteed annuities e.g. those that provide an income that increases with inflation, those with a level income, those that depend partially on market returns."

On the other hand, a living annuity provides investors with flexibility to choose their income each year (subject to regulatory limits) and where their money is invested. Investors also have the flexibility to change service providers or purchase a guaranteed annuity at any time. Any remaining capital after their death passes to their heirs. However, in exchange for this flexibility, investors take on the risk that they may outlive their savings, as well as the risk that their investment returns are poor. This means that their future income could fail to keep up with inflation, or even that investors outlive their savings.

Jensen uses the below table to illustrate that a guaranteed annuity and living annuity meet different retirement goals. "Therefore, it is unlikely that any one annuity will meet all the retirement goals of an investors. As a result, investors are likely to have to make trade-offs between their goals."

Description:

In a living annuity, investors are obliged by law to draw an income between 2.5% and 17.5% of their investment balance per year.

To illustrate this, Jensen uses the example of a 65 year old who has accumulated R1million for his retirement and is going to draw an initial income of 5% of his savings. This translates to an income of R50 000 in the first year or R4 167 per month. He then increases this income each year by inflation. The risk is that the amount he wants to draw down will eventually exceed the maximum limit of 17.5% of his remaining savings. In this case, he may end up with increasingly less income every year.

Jensen says that a rule of thumb is that your gross drawdown percentage in a living annuity (the income you are drawing plus the fees you pay as a percentage of your investment value) should not exceed 6%. "In this case, your income should, on average, keep pace with inflation for 30 years if you are invested in a medium or high equity portfolio. However, should you invest in a low equity portfolio, this will only last you 18 years on average."

"Although your lifestyle may change when you retire, the fundamentals of personal finance do not. You will still need to prepare a budget, control your expenses and monitor the rate at which you are using your retirement pot. The vital thing is to realise that, even if retirement is the end of your working life, it is not the end of your financial life," concludes Jensen.

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