Making Your Income Last Through Retirement

Very few people have enough savings to enjoy a comfortable retirement. It is therefore very important to plan ahead to ensure that you will have enough capital to last you post-retirement. It is also crucial to understand your financial position and needs as early as possible, as sometimes the consequences of your planning are reflected years after you’ve already retired. Below are the five important decisions to think about when planning for retirement.

Guaranteed life or living annuity?

There are two main risk factors that retirees need to consider: they might run out of their savings, or inflation might negatively impact their money’s buying power. Guaranteed life and living annuities, or a combination of both in some cases, can help to manage those risks.

A guaranteed life annuity protects you against the potential risk of outlasting your savings, by giving you a fixed amount of money agreed upon, for as long as you live. The amount that you obtain is determined by your age and the current interest rate, with higher incomes correlated to shorter life expectancies. You are not allowed to nor transfer your money to a living annuity, nor leave your investment to a beneficiary when you die, when you purchase a guaranteed life annuity.

The advantages, however, are that you are protected from overspending during the early years of your retirement, ensuring that you don’t outlive your savings, and the risks of poor investment choices are minimised. The disadvantage is that the terms and conditions are fixed and rather inflexible.

Living annuities provide more flexibility in terms of deciding on your own investments, unit trusts and income rates. You can leave your investment to your beneficiaries when you die, and take smaller sum at the beginning and grow it later. The downside however involves longevity and market risks.

How to choose an appropriate draw down rate?

A “draw down rate” means defining the amount of income that you can survive on, which is an important step when investing in a living annuity. The draw down rate ranges between 2.5% and 17.5%, although the suggested rate by the US financial advisor, William Bengen, is 4% during your first retirement year. He also suggests to annually increase and decrease your withdrawal’s absolute cash value by inflation.

Everyone has their own specific needs and goals. It is best to consult with an independent financial advisor to figure out your best options and get advice on the best performing unit trusts and investments for the future.

How should you allocate your assets?

Asset allocation is an important aspect of investing in living annuities, as it guarantees investment growth even as you draw an income. Bengen suggests that 50% should be allocated to equities. With longer lifespans, retirees should not be too conservative with their investments, and should allow opportunities for growth.

How should you account for inflation?

In protecting your money’s buying power and ensuring that you don’t outlive your funds, it is important to understand and account for inflation. If your draw down rate is 4%, and you assume an inflation rate of 5%, this means that you need a minimum of 9% return rate. Anything less than 9% will not be beneficial as you will lose money.

It is crucial to understand the effects of inflation and not underestimate their negative impact, as a big percentage of your total return on investment has to compensate for inflation before you earn anything.

Should your draw down rate be increased annually?

According to Bengen’s research, the best bet is a 50% asset allocation, 4% draw down rate, and inflation adjustment guidelines if you are to enjoy a minimum of 30 years of income. It is also important to rebalance and adjust the inflation rate every year.

When you take out a mortgage on your home you can access its equity in the form of cash to cover expenses. However, as a retiree you may not want the added burden of a monthly mortgage payment. Talking to a reverse mortgage lender can help you to get the best of both worlds because such a loan will not require you to make such ongoing payments. Instead, as the name implies, reverse regular payments will be made to you. Although it is possible to default on a reverse loan of this sort, it does not come with risks such as eviction because full payment will only be due if you pass away or willingly vacate your home. Even if the full payment becomes due for one of those reasons you or your heirs will be given the option to repay the loan or allow the sale of the home.