The global market collapse caused by the Covid-19 coronavirus pandemic has created a buying opportunity for those who are still investing for retirement, however, it comes at a very bad time for those who are about to enter retirement.
It could also undermine the income of those who rely on their investments to get by.
This highlights the need to do proper financial planning prior to retirement and make sure you are invested in the appropriate funds to manage market volatility.
ABOUT TO RETIRE:YOU CAN DELAY YOUR RETIREMENT
Rita Cool, a certified financial planner at Alexander Forbes, says most members of pension or provident funds are most likely invested in the fund’s default investment option. Most default options follow a life stage model, which means that, as you approach retirement, the fund starts to move out of riskier assets like equities, and increases cash and bond holdings.
Unless you specifically opted out of the default fund, your retirement fund has been protected to some extent if you are closer to retirement.
“The benefit of life stage strategies is that, as they scale down automatically, retirees are protected more than they realise,” says Cool.
If you opted out of the life stage default model and have a higher equity holding, you would need to consider your retirement plan holistically to formulate a strategy.
Cool says the most important thing to remember is that you can defer retirement from the fund. Even if your employer requires you to retire at a specific age, you do not have to take your retirement funds immediately when you retire – only when you need to receive an income or need your cash in a lump sum.
You will still be required to stop working for your employer, but if you have other accessible investments, you can start drawing an income from them before accessing your retirement funds.
If you are a member of a pension fund or a retirement annuity, you can take up to one-third as cash at retirement. If it was your intention to take the cash and settle debts, for example, you would be cashing in at very low market values if you took the cash right now. It could make sense to delay retirement from your fund until markets have made some recovery so that you maximise the lump sum available.
However, Cool says that, if your plan was to invest your one-third in a market-related fund after retirement, you would still be benefiting from low equity prices, and the transfer would not have a significant impact. Your investments can recover in the new investment product as long as you are in the correct portfolio after retirement.
If it is your intention to transfer your retirement benefit into a market-related living annuity, the current volatility will not matter significantly, as you are remaining invested in the market for most of your life and therefore not realising your losses.
The losses remain “paper” losses if you stay invested. It is only when you sell out the market that you actualise real losses.
The challenge is for retirees who plan on investing in guaranteed annuities, but who have a portion of their retirement fund in equities and whose assets have probably decreased.
Unlike living annuities, which are still invested in the market after retirement, guaranteed annuities utilise the amount of money you have at the time of retirement to lock in your income, which is then guaranteed for life.
If your plan was to purchase a guaranteed annuity, your retirement fund should have been moved into cash and bonds as part of the life stage model or in terms of your retirement planning.
If you still hold significant equities in your retirement fund, Cool advises that you either delay retirement from the fund if possible or, if you need the income, first use a living annuity to provide income until the markets recover and convert to a guaranteed annuity later so that you can lock in your income with the improved capital amount.
“It is important to note that you can convert a living annuity into a guaranteed annuity, but not the other way around,” says Cool.
DRAWING AN INCOME:REVIEW YOUR NEEDS AND WANTS
For pensioners who are relying on income from market-related investments such as living annuities, this market crash could have significant consequences.
Vanessa Mabophe, a quantitative analyst at Prescient Investment Management, says that the intention of a living annuity has always been that only returns generated in excess of inflation and costs should be taken as income, thereby ensuring that the purchasing power of the remaining capital (bequest) remains intact.
“It was not designed as the panacea for all those who did not save enough for retirement,” says Mabophe, who adds that, even during extreme market conditions, a drawdown rate of 2.5% should comfortably be funded from dividends generated in a pure equity portfolio.
“Capital fluctuations should not affect the longevity of the living annuity as assets will not need to be sold [at inopportune times] to fund income withdrawals. However, a fraction of clients who purchase a living annuity can afford to take the minimum level of income –a drawdown rate of 2.5% a year.”
Mabophe says that, unfortunately, most living annuity clients end up drawing down a higher amount than the minimum allowed level, which can introduce tremendous longevity risk – in other words, the risk that the capital will run out while the pensioner is still alive.
“There is no quick rule of thumb to make this problem disappear. The balance between the level of income drawdown and the structure of the underlying asset portfolio to optimise the longevity of the portfolio is complex, and it is critically important to engage the services of a qualified financial adviser to help with these decisions,” she says.
The impact will depend on the underlying portfolio, and a well-diversified portfolio with cash and bonds will be better protected.
Financial planner Sunel Veldtman, CEO of Foundation Family Wealth, says they are advising their clients to review their budgets.
“Now is a time for needs. Focus on what you can control – your spending. And, of course, you are at risk so the best thing for you is to look after you health. If not, you will have expensive medical bills.”
She adds that you should also review the drawdowns to assess how the market decline will impact your income. As you can only select your drawdown rate once a year, it is not something you can change immediately, but you need to decide what you can afford for your next drawdown selection.
“Clients must mentally prepare for the worst – a long downward market as we start to understand the impact on the global economy. We must face the fact that markets are becoming more volatile. This kind of volatility is now a feature of our lives, so we must try to build it into our financial plans,” says Veldtman.
Cool says guaranteed annuities are offering particularly good rates. A 65-year-old with a joint life with profit annuity targeting an increase each year of 70% of inflation can receive a rate as high as 7.5%.
Considering the maximum recommended drawdown rate for a living annuity is 5% with no guarantee increases, many retirees could be better off opting for the guarantee.
They will also not be subject to the same volatility of the market, and their incomes can never reduce, only increase in terms of their chosen increase pattern.
People worry that a guaranteed annuity does not allow them to leave anything for their children when they die.
Cool says people should realise that the breakeven point for a guaranteed annuity, depending on which increase pattern is chosen, can be between 12 and 15 years, by which time you have received all the money you used to purchase the annuity back.
Cool adds that retirees often opt for a living annuity in the hope that they can leave money to their children, but run out of money and end up relying on their children financially instead.
You can purchase a guarantee as part of your annuity that guarantees the minimum payment from this annuity. For example, if you purchase a 10-year guarantee, the annuity will pay for at least 10 years.
If you pass away in year two, your beneficiaries will receive your income for the other eight years. In this way, you and your beneficiaries can still receive substantial value from the money used to set up the guaranteed income.