Setting up your finances early as a young individual: a guide to retirement savings and living annuities

It’s a good idea to set up your savings plans and to start educating yourself on savings and investment products such as retirement annuities and living annuities as soon as you start earning a salary. Retirement may seem like a distant prospect at this point in your life, but the benefits of setting up a retirement and savings plan early on in your career are vast.

Retirement products such as living annuities are popular retirement income solutions and for good reason. They are flexible, long-term retirement investments that will provide you with an income ideally lasting through your retirement years, whilst also giving you a good chance at financial stability, which is most people’s goal in retirement. There is plenty to consider when setting up your finances, and in this article, we will cover all the key details.  

Understanding living annuities  

A living annuity is a flexible retirement income solution that allows you to invest your retirement savings to draw a regular income while also giving your capital the chance to grow. This is important, as balancing capital preservation and capital growth during retirement is key. A living annuity is funded on retirement by savings from your retirement annuity, pension or preservation fund. You can take a maximum cash withdrawal of one-third of the capital savings (for retirement products with a value above R247,000) and transfer the remaining two-thirds to a living annuity. The living annuity then provides you with your income as a retiree.

The way in which living annuities work is slightly different to other annuities, such as guaranteed (or ‘life’) annuities, which also provide you with an income.   While you can also purchase a guaranteed annuity with your retirement savings, and they will provide you with an income in retirement, your income will be set for the rest of your life. A guaranteed annuity represents an agreement between the retiree and the life assurance company that the investment risk lies with the life assurance company – no matter what happens in the markets, you will receive whatever income is agreed. However, you will likely forfeit your capital after you pass away, and you will have no flexibility or growth potential with your investment.   

A living annuity, on the other hand, allows for much more flexibility, giving you the freedom to choose your drawdown rate each year. You can choose a drawdown rate of between 2.5% and 17.5% annually. This can be amended each year depending on your financial needs at that time.   You also have more control over your investment as you can choose the underlying portfolios in which the living annuity is invested, giving you the freedom to adjust the asset allocation as you see fit and allowing you to potentially gain from any market growth.

If you are unsure about the investment options available to you for your living annuity, it would be smart to speak to an experienced investment consultant at 10X (completely free of charge).  

Starting your retirement savings journey early

There are a number of benefits to early retirement planning. Let’s have a look at some of the key advantages.   

• You can choose more aggressive underlying investments as you can afford a greater degree of risk. This allows you to potentially realise greater returns on your investment by capitalising on market cycles over time. You also have more time to recover from market downturns.  
• If you’d like to retire early, then starting your retirement savings while you are still young could set you up for the possibility of that early retirement. Perhaps you could aim to retire at age 55 instead of age 65, depending on your goals or plans. 
• You can reap the benefits of compound interest. Compound interest is extremely powerful – the longer you are in the market, and the more money you have invested, the greater your returns will be (as you are earning interest on the initial amount you invested plus all the interest you have already earned).  
• Reducing stress. By starting with your retirement savings plan earlier in life, you take the pressure off yourself later in life. If you instead leave retirement savings to when you are older, you put more pressure on yourself to put aside larger amounts of money to make sure you are saving enough to meet your retirement needs. 

 By being intentional with your retirement savings and putting together a solid retirement plan, you can set yourself up well for retirement. With financial goals, you can hold yourself accountable and check in with your progress to make sure you’re on course with your savings plans.   You can use the 10X Retirement Annuity Calculator to see where you stand financially. By inputting your age, monthly salary, current savings and the amount you can save per month, you can check the health of your retirement plan. 

What is the Golden Equation?

The Golden Equation is an important concept in retirement planning and states the following:  ​ ​

Drawdowns + Fees + Inflation ≤ Investment Returns

When you are retired and drawing an income from your investments, you should always try to ensure that your investment returns are greater than, or at least equal to, what your costs are in drawdowns, fees and inflation. Let’s look at each part of the equation in a bit more detail:  

Drawdowns: Drawdowns are the income your draw from your living annuity investment. Your drawdown rate can be selected annually depending on your financial needs for that year. Your financial needs could fluctuate from year to year, depending on factors such as whether you are earning a side income, investment returns and your health. The payment frequency can also be changed to annual, biannually, quarterly or monthly payments depending on your requirements. The drawdown rate you are able to select from ranges from 2.5% to 17.5% per annum. In order to preserve your capital and allow it to grow, you would ideally choose the lowest drawdown rate possible for your situation and needs.  

Fees: High fees can have a significant impact on the income you get from your living annuity, and whether your investment has a chance to grow or not. High fees compound against you: did you know a 1% difference in fees can mean as much as 30% less money in retirement?   

Inflation: Inflation has the effect of reducing the purchasing power (in other words, your money will be worth less in ten years than it is now) and is something that we have less control over. However, it must be planned for.  

Investment returns: This refers to the returns made by the fund in which you are invested. Typically, investment management companies try to beat inflation by a healthy margin, and have market benchmarks against which they measure themselves.    

Keeping an eye on fees

You need to be aware of the fees associated with your retirement savings vehicles. The fees you see charged on retirement investments are typically management fees and advisor fees (with potentially some hidden transfer or performance fees included as well!). The importance of low fees can never be understated, as they can have a significant impact on how much money you actually end up with. Let’s have a look at the various kinds of fees you may encounter in more detail:  

• Management fees are the fees charged by managers to operate and administer their funds.  

• Advisor fees are the fees charged by an advisor for their services and advice. In recent years, advisor fees are more commonly charged as a percentage of your investments.  

• Withdrawal/Exit fees: When you withdraw funds from your investment, an ‘exit fee’ may be applied, so always make sure you are aware of the details. 

• Transfer fees: It’s important to get a quote before doing a transfer of your investment funds from one service provider to another, to find out what the fees involved are. Often, the transferor fund will charge a transfer fee.  

• Performance fees: Make sure you understand whether you’re going to be charged if your fund outperforms the market benchmarks. All these fees can add up!  

You should always investigate providers that charge low fees and really consider whether you are getting the value you are paying for from your financial advisor.  

High fees can quickly erode your capital while low fees can help preserve your capital for longer. The compounding effect of high fees can further exacerbate the negative effect on your investment.   

Understanding Effective Annual Cost (EAC)

The Effective Annual Cost (EAC) of an investment refers to the total costs associated with an investment product such as a living annuity over a 1-year period. This would include costs such as management fees, advisor fees, loyalty bonuses and early exit penalties.  A high EAC can have a detrimental impact on your living annuity and erode the capital quickly, especially when compounded over time, whereas a low EAC will allow your investment to grow and to provide more for your financial needs over time.  

At 10X we like to keep things simple and transparent. We don’t charge fees such as loyalty bonuses and early exit penalties. Our direct investment model means we charge a single fee which is then deducted from your living annuity. There are no additional or hidden costs. To make things easier for you, you can use the 10X EAC Calculator to check on the costs of your living annuity.  It’s important to make use of strategies to minimise your EAC in your retirement products as much as possible. Potential strategies could include:  

• Making sure you have a clear understanding of the costs involved with your retirement product and switching providers if the costs involved are too high. Choosing a provider that is transparent with their fees is vital. 
• Reviewing the fees associated with your retirement vehicle regularly and ensuring you are up to date with any fee adjustments. 
• Consider a retirement product that uses low-cost strategies such as index tracking, rather than active management, as the fees associated with this kind of investment are lower. 

Dealing with inflation

Inflation is something we need to bear in mind when planning for retirement. It reduces the purchasing power of your capital over time and therefore affects the longevity of your living annuity and the income you can draw from it. Consider the following:  

Choose a sustainable drawdown rate: It is advised to choose a more conservative drawdown rate in an effort to preserve your capital. If you choose a higher drawdown rate, you are at risk of depleting the capital quickly. Conversely, a more sustainable drawdown rate will give your money the best chance of growth. A drawdown rate of 4% is thought to be sustainable in most cases, but if you can do even less, you should consider it. 

Choose a diversified asset allocation: Asset allocation refers to the underlying mix of assets in which you are invested. Examples are equities (or stocks), property, bonds and cash. By selecting a range of different assets, you hedge against any potential negative fluctuations in a specific asset class.

Balance the golden equation: To give yourself the best chance of outpacing inflation, growing your savings and providing sustainable income, you should protect yourself from getting too conservative to early. Of course, this all depends on your existing financial situation, and nothing is guaranteed. Having other forms of income for as long as possible is a good way to not to put too much pressure on your investments.

Fund performance and net investment return

Fund performance refers to the returns generated by a fund i.e. how well the fund has performed over time. The fund performance depends on how the market has performed and also the investment strategy that has been used. For active managers, have they picked the right stocks and mix of assets? For index-tracking forms, how have the indices they’ve chosen performed? Fund performance doesn’t equate to your return on investment, because it doesn’t include any fees associated with the investment product.   To get the net investment return, or what you earn before any drawdowns and before accounting for inflation, you would then deduct any fees that would be associated with managing the investment. As you can see, the higher the fees, the more of an impact this will have on the net investment return of your living annuity.  You should look closely at net returns when making investment decisions, as this is the amount of money you will have on hand once all fees and costs have been deducted.   H2: Practical examples of why low fees matter  In a case where you’ve placed R100 000 into an investment product, such as a retirement annuity, with a strong 12% annual return rate and 3% in fees, the results would be as follows:   

After 30 years, the R100,000 investment with a consistent 12% annual return, adjusted for 3% fees, grows to approximately R1,326,768. However, after adjusting for 6% annual inflation, the real value of the investment would be approximately R231,004 in today's money.  On the other hand, with a 1% annual fee instead of 3%, the R100,000 investment grows to approximately R2,289,230 after 30 years. Adjusted for 6% annual inflation, the real value in today's money would be around R398,578. That is more than double your net investment return than in the first scenario. As such, the importance of low fees is incredibly clear.   

The ins and outs of asset allocation

Asset allocation refers to the mix of assets in which your capital is invested. You could choose to invest in real estate, cash, equities or bonds, for example. Each asset class has a different level of risk associated with it. By diversifying your asset allocation, you are ensuring that you are reducing the risk that underperformance on any particular asset has an outsize impact on the performance of your portfolio as a whole.  As a younger investor, you might want to aim for a portfolio with a higher percentage of equities, as they are traditionally the asset class with the best track record of outpacing inflation over time.

Young investors have time on their side and can potentially ride out any market volatility. You could also include bonds for more stability (but potentially lower returns), and property. If all that sounds intimidating, don’t worry, your investment manager will generally have a view on what portfolio best suits your life stage. There can be a lot to navigate for a young person when first looking into the world of investment and retirement planning, so speaking to an expert can be very helpful. 10X investment consultants have been discussing investments with clients for many years, and our website is a wealth of invaluable resources, so this could be a good starting point.   

Understanding drawdown rates

Living annuities provide great flexibility and freedom in terms of being able to set your drawdown rates annually. A drawdown rate refers to the income you can withdraw from your living annuity. In South Africa, this can be set to a rate from 2.5% to a maximum of 17.5%. It is advised to select a low drawdown rate to help sustain your investment over time.   Conversely, a higher drawdown rate runs the risk of depleting your capital too quickly. Preserving your living annuity capital is imperative in order to avoid outliving your savings. There are a few things that might influence your drawdown rate:  

• Market conditions at a certain point in time   
• A change in tax bracket 
• Changing rates of inflation.  

As you can see, it is vital to regularly review and adjust your drawdown rates depending on what has been happening in the market, in South Africa and the world. 

Living annuities and offshore investing 

An investor is permitted to invest up to 100% of their living annuity offshore, which works well as a Rand hedge and can protect your investment from local currency fluctuations. Regulation 28 of the Pension Funds Act places a cap on the percentage of a retirement product that can be invested offshore, but living annuities are exempt from this. By choosing to invest offshore you are mitigating the effects of local market volatility, while also diversifying with exposure to global markets and global currencies. You need to add up your assets and liabilities and decide how much offshore exposure makes sense. 

The benefits of direct investing with 10X

10X has a direct investment model which allows you to invest directly with us. You don’t need to go via a financial advisor and therefore you can avoid paying the high fees often associated with the advice given by a financial advisor. This money can rather be invested and contribute to the to the potential growth of your retirement capital. 

10x provides you with a variety of comprehensive online tools, calculators and resources to help you manage your living annuity yourself, as well as access to experienced investment consultants. 10X also keeps management fees low by making use of index tracking. (Index tracking is where the fund tries to match the returns of a specific market index as closely as possible. It is a passive investment strategy which is simple and more cost-effective) 

How to start your retirement planning journey

 The first step to saving for your retirement as a young person is to begin by putting away regular amounts of money every month in a retirement product like a retirement annuity. By being consistent, you are paving the way to the retirement you deserve. There is a lot to learn about investing, but by reading and educating yourself, you will set yourself on the right track to take control of your own financial planning journey. 

 Starting early is key. Always remember that investing is for the long term and don’t be put off by short-term events that may negatively impact your savings temporarily.  

 When it comes time to retire, be sure to understand the benefits of a 10X living annuity. This savvy retirement investment product offers superior returns, low fees, exceptional service, and up to 100% offshore exposure, with the flexibility to change income and underlying funds as your financial situation and needs change. The fees are low and transparent, further helping with the preservation of your funds through your retirement years. 

 At 10x, we know that every person’s retirement is unique. We’ve designed our living annuities to help you maximise your savings and achieve your ideal retirement lifestyle. Reach out today to learn more about what we do.