How to minimise liquidity risk in retirement

WHAT is liquidity risk in retirement? How does this affect you, and what can you do to mitigate this risk?

Liquidity refers to how easily an investor can sell an asset – for example, a house, shares or unit trusts (collective investments) – for cash, which can then be used to meet either ongoing expenses or a once-off emergency expense.

If the asset takes a significant amount of time to sell, or the investor makes a loss when selling, this is referred to as liquidity risk.

Liquidity risk needs to be carefully considered in retirement, and here I explore how this could potentially play out.

UNFORESEEN EXPENSES

Let’s consider an example. A client, Joe, has the following income streams and assets: a life annuity, which pays him R40 000 a month; a holiday house in Cape Town valued at R10 million; a rental property in Johannesburg, which generates R10 000 a month in income; and a gold coin collection that Joe believes to be worth R4m.

Joe recently fell and broke his leg, and although the hospital expenses were covered by his medical scheme and some expenses were covered by his medical savings account, Joe will have to raise an additional R3 000 a month for the next eight months to pay for his rehabilitation expenses.

Joe cannot approach the insurance company for an additional R3 000 from his life annuity, because he opted for a traditional life annuity at retirement.

He also cannot realistically adjust the monthly rental he receives by 30%.

Joe has assets that he can sell. However, they are not very liquid: the holiday house in Cape Town, for example, would take some time to sell, and he may not want to sell the house just to cover R3 000 for eight months.

Joe decides to sell some of his coin collection to cover the shortfall in income. He approaches a coin dealer who makes him an offer for a portion of the collection. The offer made by the dealer is significantly lower than what Joe was expecting. He had anticipated receiving at least market price for the coins.

Because of his situation, Joe decides to sell the coins to cover the extra expenses for the eight months.

MULTI-PRODUCT STRATEGY

What could Joe have done differently at retirement?

I believe that an income stream in retirement has to consider the potential need for emergency and unforeseen expenses.

A strategy that Joe could have adopted was to split his retirement capital among three or four different products.

First, a traditional life annuity would provide longevity protection and certainty that would have an income to meet expenses such as medical scheme premiums, food and accommodation.

In addition, he could have two or three living annuities. This will allow him more flexibility into the future, giving him the option to transfer one of the annuities to a life annuity, thereby guaranteeing a further portion of his income at a later date.

With a portion of the one-third of his retirement savings that Joe took in cash, he could have placed some funds in either a money market fund or a conservative unit trust fund to serve as an emergency fund.

Neal Sinclair is a business development manager at Glacier by Sanlam.