Income at retirement involves a lot more than sitting back and reaping the rewards of a lifetime of savings. One of the few things that we have no control over is knowing when we will die. And so, planning to have income for the full duration of your retirement, requires careful and meticulous planning. To do that, you must have a thorough understanding of the options available to you.
Most South Africans choose a living annuity as their retirement income provider. This allows them to decide how to invest their lump sum and the income amount to withdraw as a pension. About one-fifth of South Africans choose a guaranteed or life annuity. This option provides certainty of a fixed income for as long as they, and in some cases, their spouses live.
A living annuity places the investment risk, as well as the regulation of ongoing income withdrawals, on the investor. In this scenario, there is no guarantee the funds will last as long as you live. Guaranteed annuities will provide a fixed income for life – providing a longevity insurance of sorts. But this may well be at an income level that is too low to maintain a particular standard of living. Then, of course, when you die, unlike living annuities, the leftovers won’t go to your beneficiaries. This can be a risky investment decision and you can’t take lightly. One should note that the rate offered is normally linked to the current interest rate at the time of taking up the living-annuity.
Capitalise on your retirement options
Upon retirement in South Africa, you are entitled to take one-third of your pension fund, retirement fund or provident fund in cash. You must invest the remaining two-thirds in an annuity product. Floris Slabbert, Director at Ecsponent Financial Services – a subsidiary of the African financial services group, Ecsponent Limited – says the best bet is to carefully choose pension options and then be smart and hedge your risk.
“Choose a life or living annuity, or combination of both, based on your individual needs. Then invest the remaining one third smartly to supplement your income and hedge your risk,” said Slabbert.
The one-third matters too
Slabbert says that every retiree’s situation is unique and needs special attention. Specifically, with regards to advice on two big decisions:
- where to invest the two-thirds, and
- what to do with the one-third you withdraw as a cash lump sum. It is at this moment in their life that retirees can make decisions that will benefit them for life.
“One of the biggest mistakes someone can make is choosing either a life or living annuity without a plan,” explained Slabbert. “For example, a life annuity that provides an income for life but does not keep up with inflation, or a living annuity that invests in the wrong types of funds. Or they spend their non-compulsory one third on a new car, a facelift and a camper or caravan. None of these choices is wrong, but they must form part of an overall plan that will provide sustainable results in the long term, and, frankly, for life.
“A life or guaranteed annuity secures you a predetermined income for the rest of your life. However, because you are getting this for life, you sacrifice prospective returns. And when you die, the leftover balance over goes back to the fund,” said Slabbert. This is an insurance product designed to make money for the insurer that takes on the risk. Therefore, when this product is recommended, the intention of the advisor is important. At the same time, it is critical that the investor understands and is comfortable with the long-term effect.
“My suggestion, therefore, is – with the two thirds compulsory money – choose a life or living annuity, or combination, based on your needs. But then invest the remaining one third smartly to supplement your income and hedge your risk. A new car or hip replacement will become a reality in time. So make sure you have financially positioned yourself to be able to afford it when and where needed.
“A popular investment instrument that should form part of your planning are preference shares. They provide a stable, predictable income, especially from a company like Ecsponent. Additionally, unlike the income from the annuities, which attracts income tax, dividends are only subject to dividend withholding tax (DWT).
For many people, DWT at 20% is much lower than their average tax rate,” says Slabbert.
The income tax of between 18% to 28% that applies to annuity income is an important consideration. By adding preference shares to your medium to long-term investment strategy, you can lower your required income from your annuity by capitalising on the 20% tax rate. Additionally, with preference shares you have the security of fixed rates over the five years, meaning you won’t have to worry about the performance of your investment.
Certainty about investment performance
And performance is another important consideration. The JSE All Share Index (ALSI) has returned around 4.6% over the last three years. This means that those who have selected an income drawdown linked to inflation can quickly find themselves moving backwards at a rate of 0.7%. This is without factoring in platform and administration cost, which can bring the negative growth to up to 2.8% per year.
“Ecsponent has issued four different classes of preference shares. Investors currently have a choice between three of the classes, obviously depending on their unique circumstances and requirements,” says Slabbert.
Ecsponent’s preference shares are not linked to the prime rate. This means the investor who places some of the one-third of capital available in this asset class receives stable and predictable returns. The shares are redeemable after five years at 100% of the initial value. “In other words,” says Slabbert, “you have the comfort of knowing your capital will be repaid in full after five years.”
“There are multiple benefits to Ecsponent’s preference shares – fixed rates over a fixed term and capital repaid at the end of it. But perhaps most appealing is the monthly dividend payment you can rely on to supplement your income,” said Slabbert.