This is the fourth article in a series on planning for retirement, focusing on the different phases of the journey. Our first article looked at pre-retirement planning considerations, the second looked at navigating the transition phase of retirement, and the third explored the active phase. In this article, we look at the fourth, or passive, phase of retirement and making sure your retirement funding goes the distance.
By Jaco Pienaar
We sometimes hear people say their retirement savings will last for as long as they live – if they’re lucky. While it’s true you can’t predict how long you’ll live, and you can’t predict how investment markets will perform, there are ways to minimise the role of luck in your retirement planning.
One of the reasons luck plays a role in whether your retirement savings will go the distance is the fact that investment markets are essentially random. In other words, they often go up and down for some reason and there’s not much anyone can do to predict or control this. Fortunately, short-term market movements play a relatively small role in how long your retirement investments will last.
On the other hand, long-term market trends can either set you up for a happy retirement with enough money to last a lifetime, or a potentially unhappy retirement where you run out of money prematurely. This is because the returns your portfolio delivers early in retirement have a disproportionate impact on the overall outcome.
If you’re lucky, you retire at the beginning of a long-term bull run, where markets go up in value overall. But if you aren’t and you retire in a bear market where markets go down, you’re more likely to run out of money. However, if you weren’t lucky enough to retire into a bull market, you can still minimise the role of luck in your retirement finances.
Even if you have saved a substantial sum of money that should be more than sufficient to fund a comfortable retirement, if you invested your retirement savings in a living annuity, and your withdrawal rate rises above a sustainable level, then luck plays an increasingly important role. Minimising the role of luck, then, is strongly related to keeping a tight rein on your withdrawals.
What is the right level of withdrawal? If you’re a 65-year-old male when you retire, the most you should draw from your capital is 5.5% a year. So, for example, if you’ve saved R1 million, the most you should take as an income is R55 000 a year, or R4 583 a month. The figure for a 65-year-old woman is 5%, or R50 000 a year, as women tend to live longer. This is based on the average lifespan of a man who retires at 65, which is 82 years. For women retiring at 65 the average lifespan is 87.
Cutting your spending is a good way to help your retirement savings last. In the fourth, or passive, phase of retirement you will probably start to slow down a little, take fewer trips and maybe even downsize your primary residence. It makes sense that if you’re doing less, you’re also spending less money.
However, this is also the phase where health concerns such as an illness or the need to take expensive medications may arise. This should be taken into account as some expenses during the passive phase may be higher than you’ve planned for. A rule of thumb is to budget for medical costs to increase by 2–3% a year more than general inflation. So, if inflation is running at 7% per year, make sure you budget for your medical expenses to increase by 9–10% a year.
Also, what happens if you live beyond the averages? If you are budgeting to meet your living and medical expenses from your own savings in a living annuity, you need to allow for the fact that you may live to age 95 if you’re a man or 100 if you’re a woman. This is used as a rule as there is a 10% chance of that happening – planning for anything shorter is thus risky.
A further way to help minimise the role of luck in this phase of retirement is to take another look at how you’ve invested your capital. If you invested all your savings solely in a living annuity, perhaps it’s time to consider switching some of it into a life or guaranteed annuity. Remember, investing only in a living annuity for the duration of your retirement is only appropriate if you’ve saved enough capital to give you a sustainable income for life. If you haven’t saved enough, don’t rely on luck to grow your capital once you retire. Luck isn’t a strategy.
With a life or guaranteed annuity, on the other hand, the monthly income cannot go down and it is guaranteed for as long as you live, which eliminates the luck factor.
In summary, here are a few ways to minimise the role of luck and ensure your retirement savings go the distance:
Realise that even if you’re less active, your monthly expenses won’t necessarily go down because your medical expenses are likely to increase.
Consider securing some of your income by investing in a life or guaranteed annuity. Ask your financial adviser to look at your options.
Make sure to regularly review your retirement planning and investment strategy. Now is a good time to re-evaluate where you are and for how long your savings will need to last.
* Pienaar is a senior business development manager of Just Retirement Life (South Africa); [email protected]