The 5 biggest retirement decisions you can’t get wrong

Even if you’re looking forward to the end of your working career the idea of retirement can be daunting. We have an instinctive fear of using all our money up and a perfectly natural anxiety about a diminishing lifestyle. The good news is most of our concerns can likely be addressed by a few well-informed investment decisions.

Living annuity vs life annuity: make the choice that’s right for you

Choosing between a living annuity and a life annuity at retirement requires careful evaluation of your personal needs and circumstances. It’s a critical decision with potentially lifelong consequences. The key difference between the two is flexibility.

With a life annuity, you are bound to a contract that sets a predetermined income for life. While this feels more secure, it presents its own problems. Your retirement lifestyle and resultant expenses will almost certainly not be constant. You may still be very active in your sixties and seventies, incurring travel and recreational expenses, thus requiring a higher, more flexible income initially, with a lower but more secure income later on.

A living annuity helps accommodate these realities by allowing you to choose your own investments and income. Your investments (and therefore the income you draw from them) also has a chance to grow. However, this flexibility brings risk and responsibility the of making decisions that will determine the sustainability of your pension and lifestyle.

Did you know you can use 10X’s Living Annuity Calculator to see whether your savings will last throughout your retirement? You can also check the impact of fees on your money by using the 10X Effective Annual Cost Calculator.

The big unknown here is: How long will you be reliant on your retirement income? A life expectancy table can take you only so far; in fact, you have more than a 50% chance of living longer than the table suggests. Your health, and the longevity of your parents and grandparents, may be a better guide.

To accommodate greater flexibility at the outset, and potentially more security later on, you could always consider converting your living annuity to a life annuity at a later stage (you also can’t do it the other way around – yet another reason to consider a living annuity when you retire). As we age, our ability to make informed decisions diminishes, and it might make sense to take the issues of life expectancy, asset allocation and sustainable draw-down rates off the table, in exchange for a fixed, guaranteed income.

Don’t pay high fees, because there’ll be (a lot) less for retirement

Perhaps you’ve heard the high fee warning before, but it bears repeating. Assuming you choose a living annuity, your savings will be depleted not only by the income that you draw down from your living annuity, but also by fees and inflation.

Hypothetically, let’s say you’re paying annual fees of 2.5% of the investment balance in your living annuity (made up for arguments sake of 0.75% for advice, 0.25% for administration and 1.5% for investment management). If you’re drawing down at 10% every year, you will deplete your savings quite quickly, and paying 2,5% every year in fees won’t factor in as much.

But, if you are drawing down prudently, at say 4.5% every year, an additional 2,5% in fees equals more than half your retirement income and will take years off your savings. So, it’s essential that you keep your fees low, ideally below 1% per annum.

If you feel like you could be paying too much for your investments, use the 10X Effective Annual Cost Calculator. Every Rand you save in fees can mean more money in retirement.

While we’re talking fees and inflation, let’s briefly discuss what we like to call ‘The Golden Equation’. It’s a useful framework to use when working out the sustainability of your retirement income. You would want to make sure that your investment returns are either equal to or greater than the sum of your income drawdown, the inflation rate and the fees you pay. So:

Investment Returns ≥ Inflation Rate + Fees + Income Drawdown

If you balance this equation, it is mathematically impossible for you to run out of money in retirement. Let’s consider each of the other elements in turn:

Investment Returns: In order to balance this equation, the first thing to consider is whether your investment returns are as high as they could be. If you’re not sure, get a free comparison report.

Income Drawdown: You should choose a drawdown rate that ensures the sustainability of your living annuity. Research suggests 4%-5% per annum is sustainable, but every situation is different.

Inflation Rate: Inflation (the increase in the costs of goods and services) is inevitable. This means your investment returns will need to be better than inflation just to break even (and this before considering fees and drawdowns).

Get the asset allocation in your living annuity right

As already mentioned, a living annuity gives you fantastic flexibility and independence in your investment decisions. Sometimes though, this independence can work against you.

One mistake we see some retirees making with their living annuities is going too conservative too early. Fearing their retirement savings will be depleted by downturns in the market, they overinvest in defensive assets like bonds. And then, their returns don’t give them what they need to outpace inflation and sustain their income requirements (once again, low fees make a huge difference in situations like this), which means hard decisions need to be made.

On the other hand, good returns early might also make one complacent about risk. It’s good to remember that being too aggressive leaves a retiree vulnerable to market downturns that might require a while to rebound. So, you should always seek to balance growth and risk and remember to adjust your asset allocation as your age and life circumstances change.

Make your savings last

The truth is that your retirement pot may have to last for a long time, possibly longer than you imagine. To make your savings last you need to give your money the chance to earn returns that outpace inflation at a healthy rate over time, which does mean putting some money into the share market. Historically, this has been the most reliable way to build wealth. Doing so will give you the best chance of affording a higher draw-down rate or sustaining your income for longer.

Luckily, there’s no need to rely on expensive and opaque investment practices like stock picking, especially when you can own the whole market by buying into an index fund. The market beats those highly paid experts many more times than not. If you’re still not 100% clear on how index-tracking works, and how it might work for you, just get in touch.

Aside from smart investment choices, there are a few other ways to make you money last. For one, you can work an extra year before retiring. You might be surprised by how much impact just one extra year of work can have on your retirement picture.

First, you're still adding to your nest egg. If you're earning R80,000 monthly and putting away 15% for retirement, that's another R144,000 in savings for the year - and that's before counting your employer's contributions or the tax benefits.

But the benefit is actually two-fold. Working an extra year doesn't just mean more savings - it also means one less year of relying on those savings. Let's break this down with real numbers: Say you're aiming for R50,000 monthly from your retirement savings to maintain your lifestyle. With a 5% yearly drawdown, you'd need about R12 million saved up to make that work for 20+ years of retirement. By working just one more year, you're not only shortening your retirement period but also giving your existing savings more time to grow.

And speaking of growth - your current savings can do significant work in that extra year. A R5 million portfolio growing at 6% above inflation would add about R300,000 to your retirement pot - without you adding a single Rand. That could be enough to cover several months of retirement expenses.

Finally, there are lifestyle adjustments you can make and not every expense reduction requires a major sacrifice. In fact, many changes in retirement can naturally lead to lower costs:

Housing often represents the largest expense in retirement. Downsizing to a smaller home or moving to a more affordable area can substantially reduce monthly expenses while potentially freeing up capital from your property sale.

Transport costs typically decrease in retirement. Without a daily commute, many retirees find they can manage with one car instead of two, or switch to a more economical vehicle.

Entertainment and dining patterns naturally evolve. Many retirees discover they spend less while enjoying life more, as they have time to plan and cook meals at home or enjoy entertainment during off-peak hours.

Know your healthcare, estate and legacy planning situation

Lastly, here are some of those things you need to think about, but most people put off indefinitely.

Healthcare:

• What medical aid coverage do you need as you get older? What are costs likely to be? Do you need any other medical insurance products (like gap cover)?
• Do you have an emergency fund or access to cash for out-of-pocket expenses or unforeseen events?
• Have you thought about chronic medication and how that fits into your medical insurance?
• What are your retirement living and long-term care/frail care options and costs?

Estate planning:

• Is your will and testament up to date?
• Do you have a living will/advance directive in place?
• Do you need to think about trust considerations for asset protection?
• Have you thought about power of attorney in case of incapacity?
• What are your most tax-efficient wealth transfer strategies? (hint: a living annuity sits outside of your estate and allows you to pass on your capital to nominated beneficiaries)
• What are your estate duty and capital gains tax implications?
• Have you nominated and reviewed all your beneficiaries?
• Have you made provision for a surviving spouse?

Legacy planning:

• Do you have any charitable giving goals?
• Do you wish to make use of inter-vivos gifting strategies?
• Do you want to provide education funding for your grandchildren or their children?
• Is there any family business succession planning that needs to take place?

Taking charge and changing what you can

To sum everything up, when it comes time to retire or think about retiring, consider these key steps:

• Understand the living annuity vs. life annuity options thoroughly
• Calculate your essential monthly expenses, and reduce investment and other costs
• Make the right investment choices, and speak to a professional if you need a sounding-board
• Use a Living Annuity Calculator to understand how much income you can sustainably draw from your retirement savings

The comfortable retirement you deserve isn't just about reaching a specific savings number - it's about creating a sustainable financial strategy that works for your unique situation.