Lfinances. “Have I made the right decision not to take the severance package? I will be retiring in four years’ time. What should my priorities be now?” asks Livo.
Early retirement can be tempting, especially after working at the same company for so long, but it usually requires prior financial planning as you need to have sufficient funds by the age of 55.
By retiring early, you have five less years to accumulate money towards retirement and you have to fund those extra five years.
If Livo retired at 55 and lived, for example, until he reached 80, that would be 25 years of retirement income required.
THE EFFECT OF AN EXTRA FOUR YEARS
Livo was offered early retirement last year at the age of 55 after working for his company for 38 years. He decided not to take the offer, but to work until the normal retirement age of 60 as this would provide him with the time to sort out his ivo currently has a take-home salary of R24 000, with a retirement benefit of R2.9 million. Lizl Budhram, advice manager at Old Mutual, explains that while this may seem like a lot of money, it would provide him with a gross income of only R16 800 a month*.
“By delaying one’s retirement for four years and continuing to make monthly contributions to your retirement fund each month, it is possible to significantly increase the income you would receive in retirement,” says Budhram.
For example, if he continued contributing R4 500 a month to his retirement fund and earned 10% per year over the next four years, the fund would grow to about R4.5 million.
“In addition, he will be four years older and therefore receive a better annuity rate,” explains Budhram, who says these factors combined would result in an income of about R27 800* in retirement in four years’ time. This would be close to his current salary adjusted for inflation. By waiting an extra four years, Livo could retire very comfortably.
As his income needs during retirement may be less than his current needs, Livo could consider taking his R500 000 tax-free lump sum on retirement and investing the remaining estimated R4 million for income. The tax-free lump sum can then be used to provide additional discretionary income (with specific income tax benefits), or for any capital need he may have at retirement (such as a holiday or education costs for a dependant).
PAY OFF DEBTS BEFORE RETIREMENT
Livo has several debts and a child who is still financially dependent on him. He has finance on two cars, which will be paid off in the next two years, as well as credit card and other debt.
His youngest child will only be matriculating in two years’ time. Livo lives on a property owned by his employer, but he has built a retirement home and is still paying off the bond.
The fact that Livo still has outstanding debts and a child at school is another good reason to postpone retirement. “Being debt-free in retirement should be your top priority. To avoid debt at the retirement date, consider postponing the retirement date, if possible,” says Budhram, who explains that without those debt repayments, his monthly expenses will be lower and he could better manage on his pension.
PLAN FOR FINANCIAL DEPENDANTS
If Livo’s child wishes to study after completing matric, Budhram says that Livo needs to plan for this as part of his retirement costs.
“He needs to decide whether he will focus only on paying off existing debt, or whether he can also save for education needs.
“When he retires, he could perhaps use some of the retirement fund lump sum to pay towards educational expenses, but these options and implications should be discussed with a financial planner.”
REVIEW YOUR POLICIES
Budhram says retirement is also a good time to review your will, your policies and the beneficiaries on your policies. For example, does he need life insurance if his child is still financially dependent on him, or has he provided for the child’s living and education costs separately? If he does require life cover, could he convert his company group cover, or does he have life cover on his retirement annuity?
He also needs to assess his medical costs, which will increase as he gets older. He may need to consider a fully comprehensive medical scheme, gap-cover insurance or critical-illness insurance so that his retirement funds are not wiped out by ill health.
LIFE ANNUITY, OR LIVING ANNUITY?
If Livo only retires at the age of 60, he has to consider either a life annuity, which will pay him a guaranteed income for life that adjusts for inflation, or a living annuity, which allows flexibility, as he can drawdown between 2.5% and 17.5% of the capital each year.
However, it is important to note that if he chooses a living annuity, the recommended drawdown rate by the Association for Savings and Investment SA is 5%, which is most likely to provide an income below his current needs.
Living annuity: The money is invested in a portfolio and pays an income from the investment. You can select your income, but the problem is that many pensioners select a drawdown rate that is too high and this then places their future income at risk as the capital runs out. Budhram says one of the main attractions of a living annuity is that any remaining capital invested in a living annuity is retained for the beneficiaries in the event of the death of the pensioner, but with a life annuity this is not the case, unless life cover is added to the annuity.
Life annuity: This pays a guaranteed income for life, which can create more certainty and peace of mind, since the income is guaranteed for the rest of the pensioner’s life and can also include a pension for the spouse should the main member pass away.
Budhram warns, however, that there can still be the risk of the income not keeping up with inflation.
If Livo selects this option, he must select an annuity that increases with inflation each year. Initially, the income would be lower than a non-inflation-linked annuity, but within a few years, it will be worth more than the fixed-income annuity.
“This decision is one of the most important financial decisions a person will make and it is important to get good advice,” says Budhram.
It is crucial to have a detailed conversation with a financial planner to fully understand all the implications of this important annuity decision, and also to ensure that the risks attached to the options are completely understood and appreciated before making a selection.
“A strong and healthy pensioner like Livo will need to ensure that his retirement capital provides a longterm sustainable income during the retirement term. Also bear in mind that if a living annuity is selected, it is important to review the investment funds and choices underpinning this annuity on an annual basis to ensure that the investment fund choices and drawdown rates remain appropriate.
“This should be done in consultation with a financial adviser, who can assist with the necessary analysis, projections and guidance.”
*This rate was based on a single life with-profit annuity with a 10-year guarantee period
using current annuity rates