With longevity increasing and investment returns volatile, South Africans must balance immediate financial needs with the sustainability of their retirement portfolios.
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With longevity increasing and investment returns volatile, South Africans must balance immediate financial needs with the sustainability of their retirement portfolios. Kerry King unpacks why drawdown discipline, coupled with investment guidance, is more critical than ever.
In SA, we have had over 10 years of low growth, with little prospect of this changing soon. Coupled with the low growth, we have also had higher inflation than developed markets. This combination creates an environment where capital is depreciating faster than it can grow. Ultimately, persistent inflation erodes purchasing power and puts pressure on retirees who have a fixed capital base.
Most retirees have a defined capital base — their retirement savings — and they would have made certain calculations and assumptions to ensure this base will be sufficient for the remainder of their lives. If retirees draw more than planned, often due to inflationary pressures, there is a real risk that their capital base will be depleted earlier than calculated..
There are two key factors that influence drawdowns, which people have no control over: market returns and how long they live. These two factors are forcing retirees to be more conservative on withdrawal rates from their portfolios. Nobody wants to outlive their money. Beyond conservatism, it is also vital to be flexible with your income draw if market returns are lower for longer. Sticking to your investment strategy is critical to ensure your capital is sustainable long-term.
Balancing flexibility and discipline
Retirees typically have two or three options when it comes to balancing flexibility and discipline in retirement. If a retiree finds themselves in a high inflation, low growth environment, it would be optimal to have additional earnings to supplement their retirement income but this is not always possible.
I have seen this work very effectively in my family, where my dad retired at age 60 and continued to work, only drawing on his retirement capital from age 70. Delaying drawing from your retirement capital is an effective way to grow your retirement capital in your early retirement years. This works well because your asset base is at its peak and the compounding growth makes a marked impact.
Clients who have done both, have managed to almost double their retirement capital. Everyone’s situation is unique, and delaying your income draw for a couple of years can have a similar effect.
Many retirees convert their pensions into annuities, which are either fixed or living annuities. Fixed annuities are funded with your retirement capital in exchange for a monthly income, which can have different options of annual increases (fixed or inflationary). A fixed annuity guarantees income for life.
It is, however, important to note that all annuities are subject to income tax. If you choose a living annuity versus a fixed annuity, you can choose your annual income draw between 2.5% and 17.5%. By keeping the income drawn to a minimum and using your discretionary assets to top up your monthly income, you can keep your tax rate lower. This is dependent on the quantum of the living annuity.
Longevity scenarios also matter. Statistics show that 80% of women outlive their spouses, and of the current population over the age of 85, 70% are women. Women may face an increased risk of running out of money and, therefore, families’ financial planning should reflect that reality. Retirement planning should account for the ages of both spouses.
Why professional advice is vital
When planning major financial transitions, be it a change in employment, retirement or estate planning, it is vital to engage an advisor, as this could save you from unnecessary taxes or estate duty. Structuring your retirement income, your investment strategies and dynamic asset allocation can extend the life of your retirement capital. The key to long-term investing is diversification, which is where an expert can provide tailored, practical advice on how to spread your investment across asset classes to reduce risk.
Help from a financial advisor is also critical for intergenerational wealth transfer. Pension funds, including living annuities, can be important in building an effective estate plan, as they are excluded from your estate and not subject to estate duties. Pension products have beneficiary nominations and do not come into the process when winding up an estate.
Depending on how the beneficiary chooses to inherit, either cash or an annuity, there could be other income tax implications. Financial advisors can guide you through this process to minimise any unnecessary tax leakage.
Kerry King is an advisory partner at Citadel.
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