The different stages of retirement planning demand different investment vehicles to achieve your aims. At the recent Personal Finance/Old Mutual Retire Right seminars, Lionel Karp, of financial advice company Hemmes Karp & Associates, looked at investment in the retirement years.
One of the most important factors in retirement planning is getting the best income flow from your retirement savings without undermining those savings.
Lionel Karp says the traditional approach to financial planning is to start with an assessment of your investment risk profile, and then to allocate your retirement savings to different assets which provide a return that will dictate your lifestyle in retirement.
However, it is better to use a lifestyle approach to financial planning. This entails looking at the lifestyle you would like to have. Once you have detailed your objectives, a computer model can be used to work out a rate of return you will need to achieve your required lifestyle.
Once the desired rate of return on your investments has been assessed, you can select the assets you need to invest in to meet your needs. Finally, you have to be comfortable with the risk you must take to achieve your required return. If you are not comfortable with the risk, then you must start the process again with reduced lifestyle objectives.
Karp says when you need to buy a compulsory annuity with the two-thirds of your pension fund benefits (including retirement annuities) that legally you must use to buy a pension, you have a wide choice of products. Even within the same product type, you can get better or worse benefits from different companies.
The products can provide you with greater or lower levels of investment risk as well as greater or lower levels of returns. There are two main divisions to annuities: Conventional annuities and living annuities. Both have their place in providing a pension and you need to know the risks and benefits before you decide which is best for you.
Conventional annuities
A conventional annuity buys you a pension for the rest of your life. Conventional annuities, however, come in many different guises - from a level annuity which pays you a pension from the day you retire, to profit annuities which provide you with part of any investment profits the life assurance company makes on your initial investment, thereby increasing the size of your pension.
You can also buy conventional annuities that allow you to increase the level of the annuity to take inflation into account, and one that allows your spouse to take over the pension if you die.
Many conventional annuities also carry the label guaranteed for 10 years and then for life. This means that if you die before the 10 years are up, the annuity is then passed on to a spouse or other dependant.
If you die 10 years after buying the annuity, however, no one will benefit from it and what is left of the capital amount you invested is taken over by the life assurance company.
The pension paid to a woman who buys an annuity is lower than that paid to a man because women are expected to live longer.
Living annuities
The main elements of a living annuity are:
- You must select the amount of money you can draw on an annual basis. The amount you draw must be at least five percent of the capital amount or up to 20 percent of this amount.
Karp warns that you should be careful about the money you draw down, taking a minimum of five percent while you do not need the money to live on. When you are drawing a pension you should not take more than 10 percent, and only take 20 percent if you desperately need the money;
- You can decide how the money is invested;
- You can choose what will happen to the remaining capital when you die. It can either be paid out as an accelerated annuity over a five-year period or as cash to a beneficiary.
Karp says that while you must be wary of the risk of living annuities, they do provide meaningful benefits for the right investors. When you invest a living annuity, you need to take the following into account: That you have sufficient income until the day you die; the investment risk; and the risk that you do not draw down on your capital too quickly.
The upside is that the investments must conform to prudential guidelines, which limit the amount you may invest in shares to 75 percent of the total, allow you to diversify your investment properly, permit risk-free investment choices and provide transparency in costs.
In the end, Karp says, you must ensure you get the mix of annuities right.