Because you are likely to save towards your retirement nest egg over multiple decades, by the time you retire it may well be the single biggest asset on your balance sheet.
What you end up doing with this pot of money is one of the most critical financial decisions of your life, as your choice you make will determine your lifestyle for the next 25 to 30 years, says Coronation Investment Specialist Christo Lineveldt.
So what decisions do I need to make at retirement?
If you are close to retirement, you will soon need to make two decisions about the savings that you have accumulated over your lifetime. As both require careful thought, it may be best to make them with the help of an independent financial adviser (IFA), says Lineveldt.
To make this process a bit easier to navigate, Lineveldt has outlined some of the considerations linked to each choice:
1. Do I take a cash lump sum from my savings? If so, how much should I take?
Before deciding on the amount of cash you wish to take as a lump sum, you need to determine its purpose (such as settling any outstanding debt at retirement, covering any up-front retirement settlement costs or setting up an emergency fund) and whether you can afford it.
As a general rule, funding capital transactions such as acquiring an asset or settling debt is preferable to funding current expenditure.
Keep in mind that any cash amount withdrawn leaves you with less capital to purchase the annuity from which you will be drawing your retirement income.
A useful exercise to conduct with the help of your IFA is to map out liquidity scenarios over at least two to three decades, based on your personal circumstances. Importantly, the amount of money that you can take in the form of a cash lump sum is determined by the type of retirement fund of which you are a member:
Tax is another important factor to consider. The good news is the first R500 000 taken as a cash lump sum is tax free. If you wish to withdraw an amount greater than that, the following tax rates apply*:
2. Where do I invest the rest?
Whether or not you choose to take a portion of your retirement savings in cash, the balance of your investment must be used to purchase an annuity that will pay you an income throughout your retirement.
Retirement savers currently have two main options from which to draw their income in retirement: a living (market-linked) annuity or a guaranteed (life) annuity underwritten by a life insurance company. Each product has its own set of advantages and limitations (refer to table below).
The biggest difference is that in the case of a guaranteed annuity, you forfeit your capital but your income is guaranteed for life, while a living annuity offers greater flexibility as you retain ownership of your capital, but offers no income guarantee.
Many investors choose to transfer their retirement savings to a living annuity (as opposed to a guaranteed annuity), as it comes with various advantages, explains Lineveldt.
However, choosing the living annuity as your retirement income vehicle comes with the most challenging of investor needs: balancing the needs of today (drawing an income) with those of the future (achieving long-term growth).
To ensure you can sustainably draw a certain level of income throughout your retirement years requires you to invest in an appropriately constructed portfolio and then to select a conservative income rate early in retirement.
Drawing too high an income at the start of your retirement and/or expecting too high an investment rate of return is as dangerous as investing in a portfolio with an inappropriate risk profile.
Once your living annuity plan is in action, you should regularly consider the amount of retirement income you draw in response to the actual performance of your underlying investment.
By applying a few spending rules with assistance of your IFA, such as dynamically adjusting your income drawdown rate in response to returns, retirees can ensure capital preservation – your goal should be to first earn the returns before spending them, Lineveldt says.
As of March 1, 2019, investors who still grapple with choosing an annuity can consider investing in the annuity option pre-selected by the trustees of their respective retirement funds, he notes.
This follows an amendment to the Pension Funds Act that requires trustees of retirement funds to select an appropriate annuity strategy to provide fund members with a sustainable income throughout retirement.
*2018/19 tax year