Consciously apply your capital at retirement

WHEN it comes to a sustainable retirement, retirees should consider their needs in terms of the level of income required, both now and in the future, and the ability to provide for dependants after death.

However, these needs offset each other, because if you consume more capital during your lifetime, the benefit to your dependants will ultimately be smaller.

Just Retirement Insights conducted last year substantiates that leaving money for family and having a guaranteed income are the most important aspects of retirement products. But the opposing desires are compounded by insufficient retirement savings.

At the start of the retirement journey, capital is limited for most retirees. It therefore makes sense consciously to apply the capital you have to meet specific needs exactly.

When you reach retirement, expenses that increase with inflation every year continue, but there is no longer a salary or income from an employer to cover the expenses.

Retirees need certainty that their essential expenses (such as food, medical, accommodation, water, electricity, cellphone and transport) will be covered for life. Once you are sure your basic needs will be covered, surplus capital can be used to provide a flexible income, or to provide for your spouse or dependants’ financial needs after your death.

A spouse’s or dependant’s financial needs should be considered carefully in the event of your death. Typically, there are two requirements:

1. To be able to provide an income for your spouse to cover essential expenses, which should decrease following your death. Budgeting exercises have revealed that expenses tend to reduce by around 35% after the death of a spouse.

2. To be able to provide an income for a certain period to those who might be financially dependent.

An insurer can provide financial certainty and protection from outliving capital in the form of a guaranteed life annuity. Unbeknown to many, it is also possible to provide for spouse or dependants’ financial needs with certainty after the death of the main member.

DEATH BENEFITS IN A GUARANTEED LIFE ANNUITY

In a guaranteed life annuity, you might choose a spouse’s income of between 50% and 100% of the full monthly income for the remainder of your spouse’s life. In addition to a spouse’s income benefit, there is an option to secure a monthly income for a set period, regardless of whether you, your spouse or dependants pass away. For example, you could consider securing this income until the time your last dependant reaches the age of 18 or 21.

DEBUNKING LIVING ANNUITY DEATH BENEFITS

The perceived death benefit for beneficiaries is often cited as a reason people select a living annuity over a guaranteed life annuity at retirement. However, this death benefit is an expensive self-insured benefit, which might not be well correlated with the income needs of the beneficiaries.

In the early years of retirement, the death benefit within a living annuity is generally larger than beneficiaries require. This high death benefit comes at a cost – and the cost is to forego consumption and draw a low rate of income of under 5% a year (for a couple in their sixties) if this is to be sustained for life.

If the retiree, instead, were to consume more income from their living annuity, the level of income would not be sustainable for life. The capital available at their expected date of death would also be significantly below the level required by dependants.

In fact, instead of leaving a death benefit, the retiree is more likely to become dependent on family members or the government when their money runs out.

The option best suited for you would largely depend on the amount of capital available at retirement, your lifetime income needs and the needs of your dependants. There are also new developments that allow retirees to combine both types of death benefits in a single product.

Twané Wessels is a product actuary at retirement income specialist Just. She is a member of the investments committee of the Actuarial Society of South Africa.