RETIREMENT: A QUESTION OF TIME
BRUCE CAMERON
EDITOR: PERSONAL FINANCE
Agenda
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Why you need to plan
How much you need
Long-term savings choices
Pension choices
The risks you face
The need for advice
Reasons to plan
• What you need, why you need it and how long it will
take
• Taking account of the threats: Inflation, investment
market returns/volatility and living too long
• Finding the products that will generate enough capital
to provide a sustainable income in retirement
• Taking account of risk you can and cannot take
(when you have insufficient capital) in your asset class
and asset management choice
• While minimising taxation
• And planning your estate.
No plan: You become a statistic
• Only 26% of retirement fund members will reach
retirement financially secure
• To achieve a financially secure retirement you need
to save at least 13 cents of every rand you earn in
your life
• Most fund members contribute between five and six
cents of every rand they earn
• Average period of contribution: 27 years and six
months – instead of 40 to 45 years
• Most people go into retirement with a pension
equal to 28% of their last pensionable pay cheque
Planning: A matter of options
Retirement funding is deciding what pleasure you will
forgo now to have some pleasure in retirement
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Too little saved = Poverty in retirement
Retire early = less in retirement
Live too long = Depletion of cash
Too much saved = Unnecessary sacrifices before retirement
The Build Up:
Calculating how much you need
It is not a quick calculation:
• Capital amount of 10 x annual income is Not Enough
• It will be closer to 15 to 20 x annual income
You need to start at the end, not the beginning
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Your lifestyle in retirement
Your age at retirement
A sustainable income in retirement
Capital required to generate a sustainable income
Type of annuity (pension) – this is variable
The Build Up: Tax-Incentivised
Retirement Savings Vehicles
Occupational Retirement Funds (mainly sponsored
by employers):
• Defined Benefit Funds
• Defined Contribution Pension Funds
• Defined Contribution Provident Funds
• Umbrella Funds
Individual vehicles:
• Retirement Annuity Funds
• Preservation Funds (Pension & Provident)
Occupational Funds
Defined benefit funds:
• Contributions up to N$40 000 a year deductible from taxable income
• You know what you will get (Final salary x years of membership x a
factor)
• No investment risk for you
• Must use two thirds to purchase a pension – subject to income tax at
marginal rate
• Lump sum tax free
Defined contribution pension funds
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Contributions up to N$40 000 a year deductible from taxable income
Contributions by your employer and yourself defined
No benefit guaranteed - Investment risk all yours
Must use two thirds to purchase a pension – subject to income tax at
marginal rate
• Lump sum tax free
Dangers of Occupational Funds
• Mind the Gap: No employer sponsored scheme is
sufficient. Most funds aim to provide 70 - 80% of
pensionable income after 40 years of employment.
• Contributions based on pensionable income: Final salary
excludes all allowances
• Big gap for dependants/disabled: Beware DC funds
when you are younger. You need more life assurance.
Most DC funds only have assurance cover of between 2
and 3 times annual pensionable income
Individual Retirement Funds
Retirement Annuity Funds
Legal structure:
• Contributions up to N$40 000 a year tax deductible
• Must use two thirds to purchase a pension – subject to income
tax at marginal rate
• Lump sum tax free
• May only be matured at age 55 or older.
Product choices
• Life assurance: Normally contractual with penalties for reducing
or stopping payments. Warnings: Higher cost and long-term
contracts (based on commission).
• Linked Investment Services Product: Greater investment choice.
Non-contractual but can be costly.
• Unit trust: Choice limited to the management company. Noncontractual. Costs will depend on asset management house
Individual Funds
Preservation Funds
Legal structure:
• Amounts transferred from occupational funds
• No new contributions
• Preserves tax status of previous fund (pension or preservation)
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Product choices
• Life assurance: Normally contractual with penalties for
reducing or stopping payments. Higher cost.
• Linked Investment Product: Greater investment choice. Noncontractual but can be costly.
• Unit trust: Choice limited to the management company. Noncontractual. Costs will depend on management company
Before and at retirement
Decisions must be made on annuity (pension).
Annuity choices are:
• Fund-provided pension: normally a defined benefit
occupational fund
Or
• Voluntary purchase annuity (VPA): pension bought with aftertax money, including discretionary savings and proceeds of a
provident fund.
Or
• Compulsory purchase annuity (CPA): pension bought with
proceeds of a tax-incentivised occupational pension fund or
retirement annuity fund
Main CPA choices
Guaranteed life annuity: a life assurance company guarantees
you will be paid a pre-determined pension for life (level,
escalating, capital guarantee, joint and survivorship options).
Pension depends on gender, age, interest rates, guarantees
and product. Dies with you (depending on guarantees).
And/or
With profit annuity: a life assurer guarantees you will be paid a
minimum pension for life but increases will be dependent on
investment returns. Dies with you. Only available in Namibia
through an occupational fund
And/or
Investment-linked living annuity (ILLA): you take the risk of
ensuring that you will have a sustainable pension for the rest of
you life. Must drawdown between 5 and 20 percent. Lives
after you.
Main threats to a financially
secure retirement
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Not planning holistically (with proper advice)
Starting to save too late
Not saving enough
Withdrawing savings before retirement
Retiring too early
Inflation
Costs
Tax
Investment choices
Product choices
Living too long
Dying too soon
Choosing the wrong annuity
Advice Risk
1. Not planning holistically
Finances are a balancing act which require:
• Taking some risks yourself and sharing others with others.
• Deferring spending (saving)
• Taking account of affordability (debt)
Best solution:
• A financial needs analysis
• With regular check ups, particularly when circumstances
change
2. Starting to save too late
Assuming a regular savings pattern every N$100 in pension income you
receive in retirement, N$65 will be from money you saved (with the
investment returns) before the age of 45.
Percentage of income required at different ages for a 75 percent NRR:
Current Age
Targeted
Retirement Age
55
60
65
20
10%
7%
6%
30
16%
12%
8%
35
22%
15%
11%
40
32%
20%
14%
50
51%
48%
27%
103%
44%
55
Assumptions: Target 75% of final annual salary with a 3% real return
Source: Sam Robson, Glenrand MIB
3. Not saving enough
• Don’t mistake high income with high net wealth
• Save below the required minimums and you will not
achieve your target
• Save less at the beginning and you need to save a
lot more at the end
4. Withdrawing savings before retirement
Alexander Forbes research shows that after 40 years
of potential fund membership:
• 12 percent of fund members reach retirement with an NRR of
more than 75 percent;
• Seven percent of fund members have an NRR of between 60
and 75 percent;
• 10 percent of fund members have an NRR of between 45
and 60 percent;
• 14 percent have an NRR of between 30 and 45 percent; and
• 57 percent of retirement fund members have an NRR of less
than 30 percent of their final pay cheque
One cause:
Non-preservation reduces potential NRRs of 75 percent by
between 15 and 24 percent
Non-Preservation
Non-preservation
A problem in Namibia as well
• Total amount of withdrawals not preserved
during 2009 was N$775,791,577 (Source:
Namfisa)
• One fund manager indicated only 87 of 876
withdrawing members transferred benefits to its
preservation fund. 92% made partial or total
withdrawals. (Source: C. Schlettwein Deputy Minister
of Finance Statistics)
5. Retiring too early
Replacement ratios:
Retirement
Age
Age Now
20
30
40
50
60
77.8%
50.4%
29.1%
12.5%
61
83.3%
54.4%
31.8%
14.3%
62
89.4%
58.7%
34.8%
16.2%
63
96.0%
63.5%
38.1%
18.3%
64
103.2%
68.6%
41.6%
20.7%
65
110.9%
74.1%
45.5%
23.2%
6. Inflation
Inflation and being too conservative:
• R1 000 a month X 480 months = N$ 480 000
• Average annual return of 8%
= N$3 221 070
• Average annual inflation of 10% = N$ 340 329
SO: The buying power is R340 329
Note:
• Inflation of 4.5% will reduce a fixed pension by 25%
every six years
• Inflation of 7% will halve a fixed pension every 10
years
How you need to counter inflation:
Assumptions: Inflation at 4.5 %. Drawdown 6 percent%
7. Costs
• Percentage points seem low : Every one percentage
point saved in costs will improve your end benefit by 20%
over 40 years
• Rusconi's 2004 research on retirement saving
vehicles:
- Most cost-effective is a larger occupational retirement fund.
- RA with unit trust funds sold will be reduce end benefit by
between 22.3 and 32.5 percent over 40 years.
- Life assurance RA will reduce benefit by between 30.8 and
44.7 percent over 40 years..
They just nibble away
8. Tax: Incentivised retirement products
Income tax: (EET) for pension funds and RA funds:
Exempt from income tax: Aggregate of N$40 000
for contributions to all retirement funds
Exempt from income tax: Investment returns
Taxed: Pension as and when received:
- Lump sum: Tax free.
- Pension: Taxed at marginal rate
Big Advantage: Deferred tax on balance of capital
Tax: The simplified N$40 000 problem
Annual Income
Tax
Deductible
Tax
Incentive
Capital
NRR on
N$40 000
Additional
Capital
Pension
Required
Additional
NRR
N$266 666
N$40 000
R1.6m
75%
N$400 000
N$40 000
R1.6m
50%
N$800 000
N$300 000
25%
N$500 000
N$40 000
R1.6m
40%
N$1.4m
N$375 000
25%
NS1 m
N$40 000
R1.6m
20%
N$4.4
N$750 000
55%
N$200 000
Assumption: 15% of taxable income for 40 years = 75%NRR
8. Tax: Non-incentivised savings products
Life assurance products:
Income tax: In hands of insurer
No exemptions apply
Collective Investment Schemes: (Conduit
principle) Your marginal rate after
exemptions
9. Investment Choices (Saving & Dis-saving)
Some facts of life:
• The best tax free guaranteed return you can get is
paying off your debt
• The cheapest equity investment is in Exchange
Traded Funds (and in the long term you may
probably do better)
• Diversity of investments is the proven best solution
• Exceptional promises of returns come with
inordinately high risks – If it sounds too good to be
true, it will be too good to be true
Investment Choices – Reg 28
Prudential regulation:
• Dictates how much you can invest in asset classes
and sub-sectors
• Aims at diversity of investment
But:
• Does not force you into a low yielding portfolio
• Applies to tax-incentivised retirement savings (by
law) and investment linked living annuities (by
industry agreement)
Investment Choices – Danger lurks
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Masterbond
FundsTrust
Supreme Holdings
Fedsure
Saambou Bank
Fedbond
Leaderguard (Currency speculation)
Pyramids (Rainbow, Kobus Mil, Madoff)
Publiserv medical scheme
Insider trading
Alexander Forbes (Secret profits)
Life assurance confiscatory penalties
Unregistered money market funds (Ovation: Common Cents, CMM)
Fidentia
Property syndications/fractional ownership (BlueZone/Sharemax)
That Balancing Act again
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Inflation versus returns
Greed versus fear
Costs versus returns
Tax versus tax
Risk versus returns
Too conservative versus too aggressive
Passive versus active
And you cannot rely on averages
Assuming constant real after-inflation
returns is dangerous for:
- People planning for retirement
- For pensioners living off an investment linked
living annuity
It all depends where you are in the cycle:
Example: Fund member 10 years from retirement:
1998 retiree: NRR of 8x pensionable salary
2008 retiree: NRR of 14x pensionable salary
(Source: Daniel Wessels)
You cannot combat fate
Volatile markets
9. And your NRR will vary
Retirement Age
Investment 60
Return
63
65
CPI+5%
39%
49%
56%
CPI+6%
46%
58%
67%
CPI+7%
54%
69%
82%
Assumptions:
1.
Join age 35
2.
Contribute 13% of salary
Source: Simeka Employee Benefits
10. Product Choices
- Guaranteed versus no guarantees
- Capital guaranteed index linked (synthetic)
versus life guaranteed product (non-synthetic)
- Contractual (life assurance RA) versus noncontractual (Unit trust RA)
- Limited underlying investment choice (single
balanced/flexible portfolio) versus wide
investment choice (multiple funds)
- High profile brand (often higher cost) versus low
profile brand
Warning: Only invest when you understand all –
There is no such thing as silly question
11. Living too long
• Many pension plans based on a 65-year-old dying
at 84 but 50% live longer
• One person in a couple aged 65 has a 52% chance
of reaching age 90
• A living annuity with a 3% average real annual
growth and 5% drawdown has a 25% chance of
lasting until age 90
• First person to live to 150 is already 50 years old
12. Dying too soon (pre-retirement)
• Most South Africans will die before age 50 – but not
PPS members… unless… Your chances of being
involved in a motor accident are one in ten
• 80 percent of retirement fund member beneficiaries
receive less than 50 percent of what they require
• Most South Africans are under-insured
• Insurance is there to ensure that there is sufficient
when life deals you a bad hand.
But it is a continual balancing act…
• Too much insurance = you go without
• Too little insurance = you and your dependants go
without
Dying too soon
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A child is born
Saving target R150 000 in 18 years
You die after 10 years
You have only saved R60 000
You need to cover the risk
But say you die after 15 years and investment
markets have been good:
• You only need R10 000
• You are still insured for R150 000
Dying too soon
Health warnings:
• Life assurance is not to make dependants rich –
that will make you poor while you live
• Compare premiums
• But cheap assurance can be expensive (watch
the premium guarantees)
• Be on with the new love before you are off with
the old (apologies to Will Shakespeare)
• Remember you have group life assurance
• Be cautious of accident and big toe assurance
• Always confess to the dickey heart and
weekend sky diving
13. Choosing the wrong annuity
• Once you purchase a guaranteed annuity, you are locked
into that annuity for life - life assurance guarantee is
calculated using your average expected life span and the
prevailing long-term interest rates
• Do not have to buy a single annuity with all your retirement
capital:
– split annuity derived from the same source
– Interest rates: the higher the rate the sooner to consider locking in
- the lower the rate the later.
• Age: the older you are the better the yield – taking account of
interest rates optimum time from age 70
The older you are the better it gets
Male buys a level annuity with R1 million - implied yields are:
Age 55: R93 288 a year - 9.33% implied yield
Age 60: R100 976 a year - 10.1% implied yield
Age 70: R125 134 a year - 12.51% implied yield
Age 80: R171 770 a year - 17.18% implied yield
Age 85: R210 280 a year - 21.03% implied yield
(An implied yield is the annuity (pension) divided by R1m
expressed as a percentage)
14. Advice
Nearly everyone needs financial advice – but it can be a
double-edged sword:
• No advice and you may not get the balance right and make
wrong investment decisions.
• Bad commission-driven advice and you will not get the
balance right
Getting the right advice
• Consider dealing with an organisation, such as a financial
advice company or network, rather than a one-person
operation. Organisation should have a competent team
• Beware of what are called broker funds, often used to
charge extra fees
• Best-qualified advisers have a certified financial planner
accreditation from the Financial Planning Institute
(www.fpi.co.za)
• Pay for it – preferably a fee for advice – not a commission
for product
What a good adviser should do
• Provide an annual projection to show if you are on track
with your NRR _If not how much more you need to save
and/or whether you must change your projected
retirement date.
• Provide an annual death benefit needs analysis that shows
the level of death benefits required for your dependants to
be provided with sufficient income.
• Provide an annual needs analysis of your requirements for
inco0me replacement in case you are unable to work
• Tell you how your financial security in retirement will be
affected if you do not preserve your retirement savings if
you leave the fund before retirement.
• Tell you, long before your date of retirement, what pension
you can expect based on actual quotations from the
market (showing pensions under different options).
• Tell you if your investment options are inappropriate. For
example, you may have chosen a cash portfolio while you
are relatively young or have switched to a high-risk
investment in the hope of earning better returns,
particularly when you are close to retirement or in
retirement.
Questions
Before I retire……
Q&A