The stress that inevitably comes with formal retirement is often exacerbated by the sheer number and complexity of critical decisions that need to be made at the start of this life stage. Importantly, none of the decisions can be made in isolation as they are all inter-connected and form part of a broader decision-making process which is important to get right the first time.
Here we explore a number of important decisions and what to consider in the evaluation process.
Whether to take a cash portion
Being wholly invested in an annuity structure such as a living or life annuity can lead to liquidity and cashflow problems later in retirement, which makes assessing your need for discretionary funding an important part of the decision-making process, specifically when it comes to budgeting for larger capital outlays or expenditure. While you may be confident that your annuity income is sufficient to cover your post-retirement living expenses into the future, it’s important to prepare a realistic retirement budget that caters for large one-off expenses such as overseas travel, a vehicle purchase, the cost of a wedding, or a grandchild’s education.
Through the retirement fund harmonisation process, provident, pension and retirement annuity funds are now subject to the same rules on retirement – with the exception of those provident fund benefits that vested prior to 1 March 2021 – meaning that all retirees have the option to commute one-third of their benefits subject to tax. While the first R500 000 is free from tax, bear in mind that this is wholly dependent on whether any previous withdrawals have been made from one’s retirement funds, and it is therefore always advisable to request a tax simulation before making a withdrawal to ensure that you fully understand the financial implications of doing so.
Having an appropriately sized and easily accessible emergency fund in retirement is critical and if you don’t have access to such a fund, making a cash withdrawal can be critical to your future financial security. Ideally, sit with your advisor so that you can make informed decisions regarding any commutation of benefits and the purpose they will serve in your overall portfolio.
Purchasing an annuity income
As a retiree, potentially the two greatest risks that you face are (a) the risk of outliving your capital and (b) the value of your capital in real terms being eroded by inflation. As such, choosing an annuity that is best structured to mitigate these risks is a retirement planning fundamental.
Generally speaking, retirees have the option of purchasing a living annuity, a guaranteed life annuity, or a combination of both, depending on their particular needs and circumstances – and it is important to differentiate between the distinctive characteristics of each type of structure.
A life annuity is an insurance contract between the insurer and the retiree which promises to pay a guaranteed income for life, with this income often being inflation-linked. When the insured dies, the policy terminates and there is no remaining benefit available for the deceased’s heirs or beneficiaries. As it is an insurance policy, the insurer assumes the investment and longevity risks, while on the downside the insured is left with no financial assets to bequeath in the event of his death.
On the other hand, a living annuity – although often referred to as a policy – is actually an investment held in the name of the annuitant, and the annuitant has full investment flexibility when it comes to constructing their investment strategy. As such, the annuitant assumes all investment risks as well as the risk of outliving their capital although, in the event of their passing, the capital remaining in the living annuity structure can be bequeathed to their nominated beneficiaries.
As the owner of a living annuity, the annuitant is required to draw down from their investment at a rate of between 2.5% and 17.5% of the fund value per year, and careful cashflow planning and forecasting are critical to ensure that longevity risk is adequately mitigated. A living annuity can play an important estate planning role because the funds held in such a structure are paid directly to the nominated beneficiaries and therefore do not attract estate duty. As such, choosing between a life and living annuity, or a hybrid structure, should be considered from both a retirement planning and an estate planning perspective.
Retiring from a retirement annuity
While the retirement age in respect of pension and provident funds is determined by the fund rules, this is not the case when it comes to retirement annuities. Generally speaking, a retirement annuity investor can retire from age 55 onwards although there is no age limit at which retirement should take place. As such, deciding when to retire from a retirement annuity is a critical part of one’s overall retirement and estate planning. Remember, while your funds remain in a retirement annuity structure the manner in which they are invested is subject to Regulation 28 of the Pension Funds Act which limits the offshore and equity exposure of your investment. If you retire from your retirement annuity, you have the freedom to invest your funds in a living annuity structure where you can expose your investment to as much risk as you like.
That said, while your funds remain in your retirement annuity, you can continue adding to your investment pot on a tax-deductible basis, subject to certain limits, while your investment enjoys the effects of compounding investment returns. Once you move your funds to a living annuity structure, legislation requires that you begin drawing down from your investment at a minimum of 2.5% per year, and this income is taxed at your marginal rate. As such, it is important to carefully analyse the impact of retiring from your retirement annuity will have on your overall plan to ensure that the timing is appropriate in terms of the broader plan.
Realising your primary residence
Appropriately timing the sale of your primary residence is imperative, not least of all because the decision can be a hugely emotional one which can become more overwhelming with age. Further, if your retirement plan is dependent on some or all of the equity held in your property, getting the timing of the sale right in order to maximise the realised value is essential. In our experience, many retirees tend to hold onto the family home for much longer than is necessary as they become increasingly reluctant to give up the memories and familiarity of the home they’ve grown accustomed to living in. The maintenance and upkeep of a large family home and garden often become unmanageable for the elderly which, in turn, affects the market value of the property when they eventually do decide to sell. From a psychological, physical and logistical perspective, realising the family home sooner rather than later is likely to have more favourable outcomes than holding onto a property that has out served its purpose.
Choosing retirement accommodation
Having said that, selecting appropriate retirement accommodation should come hand-in-hand with the decision to sell the family home and, with suitable retirement accommodation in short supply, this is a process that should begin at least five years leading up to retirement. Options for retirement living include downscaling to a smaller freestanding property or townhouse, buying into a life rights retirement village, renting in a traditional retirement home, or communal living with other retirees, although there are a number of important factors that should be taken into account before making a final decision.
For instance, if your health or future health is of concern to you, a retirement village with frailcare or assisted living facilities might be an attractive option. On the other hand, if estate living does not appeal to you, downscaling to a smaller lock-up-and-go retirement home might be more appealing, although you will then need to give careful thought with regard to caring options should your health fail at a later stage. Either way, choosing retirement accommodation should not be a rushed decision and our advice is to spend the years leading up to retirement doing due diligence on the options available to you, including the longer-term implications of your choice.
Deciding when to travel
When it comes to retirement planning, travel is something that many retirees aspire to and budget for. Further, more and more retirees have adult children living and working abroad, making overseas travel a high priority retirement goal. However, what many retirees fail to consider is that travel – particularly international travel – becomes more and more difficult with age. The onset of illness, compromised physical mobility and/or mental impairment can happen quickly and, as such, it’s advisable for retirees to take advantage of their good health to enjoy travel in the earlier years of retirement. As a result, when it comes to developing your retirement plan, it is important to ensure that the costs of travel are built into your post-retirement budget on a realistic timeline so that you can enjoy travel while you are physically still able to do so.