In today’s newsletter we share some thoughts on financial planning – it is National Financial Planning Week, and we take a look living annuities.
December is usually a signal for holidays, festive celebrations and well-earned breaks to start. The beginning of the month, however is one of the busiest you will find. Today marks World Aids Day, COP 17 is ongoing in Durban, and we also celebrate National Financial Planning Week.
Celebrating the Financial Planner
This week marks the first FPI National Financial Planning Week in South Africa. Financial planners exist to help us achieve our goals, and live a responsible and successful financial life. Finances are a very big part of our lives – and are integrated into everything we do. We earn money from work, we spend money to live – yesterday, today and tomorrow.
But too often we remove the management of our money from our everyday lives. In money both the big and the small matter. So the amount you spend on a morning coffee adds up over time significantly, and the amount you have when you stop earning money makes a difference to how you live your retirement years.
Chairperson of the FPI (Financial Planning Institute of South Africa), Gerhardt Meyer, says it makes no sense to separate money from your life and your dreams.
Thinking of financial planning in this way is for many a mind-shift. How do you view financial planning? Is it a once a year or once off affair, do you make the best use of it to structure your earning, spending and saving? Do you have a financial plan that you live, or is it safely stored for the next review? Or is a financial plan still on your to do list? Do you look at a financial planner and see a professional who can guide you in achieving your goals and affording your life, or are you seeing a salesman?
What you put in
Financial planning is not a one-sided affair. To get the best from a financial plan both parties need to be present, accountable and willing. A financial plan can only be as good as the information provided and the actions taken.
Meyer says clients need to be open to advice when dealing with a planner. You also need to be honest – about your spending, saving and dreams. For their part Financial Planners need to be compliant with relevant legislation, codes of ethics that may apply, and international standards and practises. You can view a list of planners on the FPI website www.fpi.co.za.
When you review or redo your financial plan in 2012 consider all these things – and what you want from a financial plan, what you will do to achieve your goals and what you expect from your financial planner and yourself in the year ahead.
Investing in a living annuity can ensure a stress-free retirement
It is a commonly known fact that most South Africans are not adequately prepared for retirement. This is a serious concern, as we are not a welfare state where the state will step in and help you in your old age. Even though most people make some provision for retirement, the main focus should be that you do not outlive your capital. Unlike conventional pension products, living annuities allow you to manage your income to keep track with inflation and to ensure your capital lasts, giving you peace of mind.
Learning about gaps in pension planning from history
John Kinsley, MD of Unit Trusts at Prudential Portfolio Managers, explains how South Africans historically managed their pension or annuity when retiring from a typical retirement annuity fund. “In the past, most people invested a two-thirds portion of their money in a conventional annuity with a life office. The life office then paid you a guaranteed income stream for the rest of your life. The benefit is that you cannot outlive your capital – the disadvantage is that if you lived for a shorter period than anticipated there is no residual capital left for your dependants”, he says.
To counteract this, South Africans could buy an annuity with a minimum term or one that continues to pay your spouse after death. The drawback of these options is a lower annuity rate. They are however suitable for extremely risk-averse individuals.
Living annuities have the tools to ensure adequate capital, even after death
With a living annuity, individuals manage their own money by deciding how much income to draw every year. “By doing this and managing the process wisely (possibly with the help of a financial adviser) investors can ensure their income keeps track with inflation and that the remaining capital keeps it purchasing power,” Kinsley continues. Another big advantage is that your dependants have access to any residual capital and such capital does not attract estate duty.
Inflation, capital growth and the rate of drawdown are important
These three variables must be taken into account if you want to make sufficient provision for after you retire.
1. Inflation
“Inflation is a tax,” explains Kinsley. “It reduces the value of your money over time. You need to earn interest higher than – not less than or even equal to – the inflation rate to combat the effects of inflation.”
2. Capital growth
The second factor to keep in mind is that the rate at which your capital grows must also be higher than the inflation rate. “Investors must however keep in mind that the higher the growth rate, the greater the risk, so this is an important balancing act,” Kinsley says. Investors must look at their circumstances to determine the most optimal solution for them. There is no “one size fits all” solution and the guidance of a financial adviser may be critical here.
3. Drawdown rate
The current living annuity regulations allow you to draw an amount between 2.5% and 17.5% per year. Kinsley warns against the temptation to take as much as possible today: “The more you draw, the shorter the time your capital will be available to support you.” Investors must also keep in mind that what they don’t draw remains untaxed and continues growing.
In addition to these three key factors, there will be additional costs, such as fund management fees, product costs and financial adviser fees. Investors must take these costs into account in the total returns of the fund.
The services of a financial adviser may improve your outcome
When retirees are looking for ways to cut costs, they may do away with the services of a financial adviser. But Kinsley says this may be a mistake: “Financial advisers play a critical role in preparing an income-versus-expense analysis for your circumstances.” Research has shown that most investors who have a trusted financial adviser are better off financially over time.
The opinion and comment in this newsletter is opinion and comment only and does not in any way constitute financial advice. Please seek professional advice from a professional financial planner for all investment and financial decisions.
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