SA's No 1 Insurance Blog

Make one of these mistakes and we can tell you your fortune

I’m about to meet with Gavin who’s retiring from the company he works for.

I’ve fought through Monday morning traffic to get here. Luckily, I’m 15 minutes early so I spend it studying the people who work here.

All around people are rushing through turnstiles fumbling for swipe cards. No time to dawdle, they’re on company time now, things to get done, money to be made, meetings to be kept.
At four ‘o clock the situation is reversed with everyone once again rushing for the turnstiles, a hurried search for swipe cards as each attempts to miss rush hour traffic.

I’ve never met Gavin, but here are 3 assumptions I’m making about him based on past experience:

He wants as much as possible in cash

Is this a good thing? Yes of course it is…up to a point.

That’s because the first R500, 000 of any retirement lumpsum is paid tax-free at retirement assuming you haven’t already made retirement withdrawals in the past. The alternative is not to take any of your retirement capital as a lumpsum, convert the lot into an annuity income, and pay the tax on your income. But why do that if you can avoid all tax?

Wouldn’t you prefer taking your R500, 000 and investing it elsewhere where your only potential tax liability is:

  • Tax on interest earned,
  • Dividend tax, and
  • Capital gains tax?

But here’s the problem with taking that tax-free withdrawal

Gavin might want to use this withdrawal to:

  • settle his outstanding debts
  • buy himself a new car or
  • start a business

Truth be told, Gavin should have started planning for retirement, at the very least, five years ago. His retirement should have coincided with the settlement of all debt and the saving up to purchase a new vehicle at retirement. Now is not the time to waste precious retirement capital on debt and lifestyle purchases.
Eating his retirement seed capital is the worst thing ever. We see people making this mistake over and over again.

Determining his income based on current needs

Retirement involves a massive paradigm shift. Unless you’ve walked away with a massive pension or provident fund, chances are you’re going to have to adjust your lifestyle.

That lifestyle adjustment for the vast majority is going to be downwards. But lifestyles can’t always be adjusted downwards. That’s due to a lack of retirement planning with little thought given to getting out of debt prior to retiring.

The following scenario often plays out:

  • Monthly living expenses – R10,000
  • Monthly suggested income from my pension annuity in order to preserve it over my anticipated lifespan – R5,000 increasing with 5% every year
  • Monthly income chosen based on needs – R10,000 with no increase every year

In the scenario above, yes the R10,000 will address the income need this year, but what about the income need next year, and the year after next when the cost of living increases by 10%?

Many decisions are based on today’s needs rather than 20 years from today’s needs. The attitude is, “We’ll cross that bridge when we get to it.

The analogy of the frog in a pot of water being brought to the boils springs to mind. We’ve seen how this decision has played out before and it’s never pleasant.

He knows how to manage his investments

Gavin’s a busy guy.  He’s never had the time – or the inclination – to monitor his pension fund, and he’s always believed in leaving it to the professionals:

The Company knows where they’re investing my money, right?

The same applies to his personal investments. He’s always relied on his advisor which I must add, isn’t a bad thing at all. There’s research out there which shows that those who use an advisor invest more than those who don’t.

But now retirement looms, and Gavin decides to play a more active role

I don’t know how other advisors do it, but I always prepare quotations for guaranteed annuities when meeting with people about to retire. This is to temper their expectations.  There are also certain types of clients who should never choose anything besides a guaranteed annuity but that’s another topic.

In a later article I’ll explain the difference between annuities, but for now realise that a guaranteed annuity is the income an insurance company is prepared to pay Gavin based on his pension capital. Nine times out of ten this is way lower than what anyone expects.

The alternative is a living annuity where the income option is determined by you, the person retiring. This is an easy sell for most advisors.

So taking the example mentioned earlier:

  • R10,000 a month is the income need
  • R5,000 a month is the guaranteed annuity income being proposed
  • R4,166 a month is the living annuity income based on a 5% per annum withdrawal off of a R1 million pension fund
  • R10,000 a month is the living annuity income based on 12% per annum withdrawal from that same pension fund

Guess what?

Gavin doesn’t realise that if he wants his R1 million pension fund to still be worth R1 million a year from today; he needs it to grow by the 12% PLUS INFLATION.
If inflation is 10% a year (and food inflation is way more than this), then he needs a 22% per annum return (10% + 12%) on his investment.
No advisor in his right mind would recommend a withdrawal of 12% to someone like Gavin when the investment time frame and environment cannot support it.

Problem is, Gavin, who for years never took an interest in his investments, has overnight become an investment expert.
So what if Liberty, Old Mutual, and Sanlam are only offering me R5, 000 a month. I’ll reduce my income next year as soon as I’m able to.”

We’ve also seen this scenario play itself out and it’s never pretty.

Seeing more than one person

Ever heard the one about the guy having two watches? Apparently it’s called Segal’s law:
A man with a watch knows what time it is. A man with two watches is never sure.

I don’t know how many times this has happened with us. Someone calls asking for retirement advice. Often they’re quick to point out that they’ve met with someone at their company but they’d like a second opinion.

Now one look at the size of their pension or provident fund, and another look at the person’s investment experience as well as debt levels and we know whether to suggest a guaranteed or a living annuity. By the way, this is also why there’s such a push for you to have a financial needs analysis done.

For many, the best decision is the guaranteed annuity – or a combination of the two. Of course what happens, is that they run back to the previous advisor with our recommendations; who immediately says:

  • They’re nuts. Don’t you know that if you die all your money is stolen by the insurance company and that their kids will get nothing?
  • Why not choose your own income and leave your pension to those they love when you die, blah blah blah….

The truth is:

  • That they’re far better off relying on an insurer guaranteeing them an income for life in much the same way as their employer did
  • That they can’t choose any income they want if they want their pension money to last
  • That their investment returns aren’t guaranteed and that they run the very real risk of running out of capital making them dependant on their children.

But no-one likes hearing that advice, do they?

A final word of advice?

Build up a relationship with an advisor over a number of years before retirement. Discuss your income options long before the time. Don’t put yourself into a position where you might make one of these four mistakes.

InsuranceFundi has partnered with some of SA’s most reputable insurance and investment companies. We believe that everyone should have access to a wide range of comprehensive and affordable solutions. Pick the product you are interested in below, and expect a call-back from our partners.

Kind regards,

The InsuranceFundi Team

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