How should I invest my savings upon retirement?


Question:

I want to retire at end of year (2013), invest my retirement savings (R1.2 million) and receive a monthly income to live from. What advice do you have?

Answer:

Errol, We cannot offer you advice, as we cannot do so without doing a full needs analysis. You may to have to consult a reputable financial adviser. If you do, do not link their remuneration to the product they recommend. We can however explain your options to you. 

As member of a pension of retirement annuity fund, you must use at least two-thirds of your fund proceeds to purchase an annuity. As a member of a provident fund you may use all or a part of your fund proceeds to purchase to purchase an annuity. By buying an annuity you defer and most likely reduce the tax due on your retirement savings as you are only taxed on the annuity income you receive. You can choose between two types of annuities: a guaranteed life-annuity or an investment-linked life annuity. Provided that one annuity has a minimum income flow of at least R150 000 per year (unlikely on R1.2m), you can purchase up to four annuities with the proceeds from your pension or retirement annuity fund. 

You can also switch a living annuity into a guaranteed annuity at a later stage (but you cannot do the reverse). 

A guaranteed life annuity (also known as a conventional annuity) is essentially an insurance product that protects you from longevity risk (outliving your savings) and investment risk (poor or insufficient investment returns). It provides you with a specified monthly pension for the rest of your life. You must purchase this annuity from a life assurance company. The full pension is paid until you die you cannot purchase a fixed terms annuity that only pays out for a fixed number of years. This means your capital dies with you, and no money passes onto your heirs (unless you include a spousal benefit, but then the annuity pays out less). 

The price of a living annuity varies from time and among service providers. You need to shop around for the best deal. Please refer to two recent blog posts we have written on this subject, Epic miss - Part 1: What annuity income will your savings buy and Epic miss - Part 2: How much income will your annuity replace. The living annuity is essentially an investment product. You assume both the longevity risk and the investment risk. It becomes your responsibility to secure an adequate income for life. In return, you have greater flexibility and control over your financial affairs: you can decide how to invest your savings, and how much you wish to draw-down every year. Annually, you must draw down at least 2.5% but no more than 17.5% of your residual capital at the policy anniversary date. Your draw-down rate can change from year-to-year. Your heirs inherit whatever is left of your capital after your death (ie your capital does not die with you). 

You can define your draw-down as a rand amount or as a percentage of your residual capital. You must instruct the administrator before your policy anniversary date, otherwise your previous draw-down or draw-down rate will apply. You can choose to receive your annuity income monthly or quarterly. The maximum draw-down of 17.5% means that the amount of your annual income is not guaranteed. If your requested draw-down exceeds 17.5% of your residual capital, you will receive less than requested, which may result in a drop in your standard of living. 

 Your residual capital is affected by your investment return (which can be positive or negative), the fees you pay and the amount you draw down every year. You run the risk of depleting your residual capital during your lifetime. If your residual capital drops below R75 000 (R50 000 if you took a cash lump sum at retirement), you may cash in this residual. 

If you die before then, your residual capital is distributed to your beneficiaries, per your instructions in your beneficiaries nomination form. It is important that you complete and sign this form otherwise your residual capital becomes part of your deceased estate. As a member of a provident fund, you may take the entire proceeds of your fund as a cash lump sum. Cash lumps confer certain tax advantages: no tax is charged on the first R315 000, the second R315 000 is taxed at 18% and the third R315 000 at 27%. The balance of your lump sum is taxed at 36%. The cash lump is tempting in light of the flexibility it confers, and the tax-free portion. However, unless you have a good understanding of investing, and are able to make informed, sensible and disciplined decisions, this is generally not a good idea. The risk that you outlive your capital will be very high.

The information and answers supplied in this section do not constitute advice as defined by the Financial Advisory and Intermediary Services Act, 37 of 2002.


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