My Financial Health
In this module we look at how best to manage the money you already have. And like many people facing an extended retirement, you may need to continue to generate some form of income. It is essential that your efforts stand the best possible chance of success.
This module provides some guidelines for starting an income generating venture and you will have a financial plan to preserve and grow your retirement money?
Your Financial Health
You may be one of the fortunate few who has enough money and assets to see you through the next 20 to 30 years. For most of us, Pensions have taken a hammering since 2008 and we will not have sufficient funds.
Talk to a financial advisor to get advice on how to make the most of the money that you do have.
The difference between a conventional annuity and a living annuity
When you retire you stop working and your money starts working for you. With any pension you are entitled to do whatever you want with one-third of the money, the remaining two-thirds however, needs to be put in a compulsory annuity. You have two choices - a conventional guaranteed life annuity or a living annuity.
If you are retiring from a pension fund, you can take up to one-third as cash and must use the balance to buy an annuity. The one-third is not tax-free – the first R500 000 of your cash lump sum is tax free, provided you have not previously withdrawn from another retirement fund. The two-thirds cannot go towards buying a retirement annuity fund (RA) – it must be used to buy either a guaranteed or a living annuity, that then pays a regular monthly pension. You can only invest in a retirement annuity with the one-third cash lump sum.
In an ideal world one would want to have enough money to buy an inflation-linked life annuity that would pay a set monthly income which increased every year with inflation. The reality is that few people retire with enough money.
An annuity and life insurance are insurance products. The primary difference between an annuity and life insurance is when payment is made. Annuities pay a set amount monthly, quarterly or annually to meet future financial needs, usually in retirement. Life insurance pays the value of the policy at the time of your death.
It is recommended that you consult an accredited financial advisor who will be able to provide advice on the various products suitable to your needs.
Conventional annuity (Guaranteed)
When you buy a conventional annuity you are outsourcing the risk of living too long to the insurer. There are many types of conventional annuities but the most popular one is a With-Profit Annuity.
An annuity is purchased from an insurer and from it you will be paid a pension. The starting pension is guaranteed for the life of the principal member (and when he/she dies, a reduced pension for the life of the surviving spouse is also guaranteed if you have so elected.) The disadvantage is that the guaranteed annuity dies with the retiree. Your survivors, (except for your spouse if you choose a joint survivorship life annuity) are not entitled to receive continued payments or what is left of the lump sum after you die, should you die before the calculated life expectancy.
The insurer determines your starting pension based on
· the amount of capital transferred
· your life expectancy - this becomes a factor because it is how the life assurance company determines how long it will expect to have to pay you. If you have a shorter life expectancy, you will receive higher monthly payments, and visa versa. Women, who statistically live longer than men, generally receive lower monthly payments on a life annuity.
· the Post Retirement Interest (PRI) rate. The PRI is effectively the minimum rate of interest (or investment return) that the retirement annuity fund must earn to cover the guaranteed annuity.
[The insurer invests the assets in order to meet the contractual obligations to pensioners. For this type of annuity, the investment is generally a mix of bonds and equities which form a significant part. The equity element brings the potential for higher investment returns, which then translate into declared bonuses. If the net smoothed investment returns are say 9%p.a and the PRI rate is say 4% then the insurer will be able to grant increases of the difference (9% less 4%) i.e. 5% p.a. The improved pension resulting from the increase is also guaranteed for life.]
Good points about a With-Profit Annuity are:
· Pension cannot reduce;
· Insurer manages the investments.
Negative points of a With-Profit Annuity are:
· Annual increases are based on investment performance, so you are sharing some of the risk
· Annuity ends on last person dying;
· Once you have invested you cannot change to any other annuity.
A living annuity is simply an investment account from which you withdraw an income. The amount withdrawn is limited by SARS to a range of from 2,5% to 17,5% of capital per year. Income is usually drawn in monthly payments like a pension, although other payment options exist. The withdrawal rate can be changed once a year on the anniversary date of commencement. When you die, the residue can be left to a spouse or children, depending on who survives, failing which it goes to your estate.
With a living annuity you enjoy all the rewards of successful investment, but you also carry all the risk that this may not be the case. It is important that these risks be thoroughly understood.
· There are no guarantees of any sort;
· You may withdraw too much too soon;
· You may live longer than expected;
· Your investment may not perform well;
· The market may decline dramatically.
The net effect of this is that secure increases in income depend entirely upon investment performance and the rate of your withdrawals. Income can of necessity decrease if the capital value drops too low.
(Consider that a withdrawal amount of 10% means that your “pension” will only last for 10 years if your investments perform at 0%)
Unlike a pension from a pension fund or guaranteed annuity, where your pension is guaranteed for however long you live, irrespective of market conditions, in a Living Annuity you cannot afford to consume all your capital too quickly in case you live longer than expected.
Good points of a Living Annuity are:
· If you die, and there is money left it can go to your children;
· You can choose your own pension amount;
· If you are not happy with the product you can move your money to any other annuity.
· Low increases due to poor investment performance;
· Pension too high when you start causing your money to run out.
With a conventional living annuity:
· You are able to control the income that you draw from the annuity every year.
· You will be able to specify a beneficiary on the annuity. When you die, the beneficiary will have an option to either continue with the annuity or to take the full amount in cash (subject to tax, of course). This can continue indefinitely as the annuity maybe handed down from heir to heir.
· Any interest from rental income earned within a living annuity does not attract income tax and therefore this is a tax efficient vehicle in which to hold cash.
· Living annuities fall outside your estate for estate duty and executor’s fees purposes.
· At a later point in time you will be able to retire from you RA’s and transfer the proceeds into your living annuity.
· A conventional living annuity is not final, unlike other annuities. You can—at a later stage—convert a portion of a conventional living annuity to either a guaranteed escalation annuity or a with profit annuity (see glossary).
Increases: No annual increase. However, you have an option to choose a flat annual increase, eg 3%, 5% or 10%. This will reduce the initial income you receive. Pension is paid for as long as you are alive.
Advantages: If no annual increase is chosen, the initial pension is higher. The pension is paid for life. You can opt for your spouse to receive a pension when you pass away.
Disadvantages: Income doesn’t increase unless chosen—therefore it doesn’t keep up with inflation. You are not able to adjust your income level as time goes by.
With profit annuity
Increases: The insurance company decides on annual increases—depending on investment performance. Pension is paid for as long as you are alive.
Advantages: Initial pension and increases declared by insurer are guaranteed for life. Insurance company takes the risk of poor investment performance. The pension is paid for
life. You can opt for your spouse to receive a pension when you pass away.
Disadvantages: You have no say in where your money is invested. The pension increases can be low or even 0% if markets are performing badly.
Inflation linked annuity
Increases: Increases are based on inflation during the year. Pension is paid for as long as you are alive.
Advantages: Your income keeps up with inflation and is protected against increases in the cost of living. Your spouse can receive a pension when you pass away.
Disadvantages: The pension increases can be low or even 0% if inflation is low or 0% respectively.
Increases: You decide on the level of income you need to get every year with a financial adviser (within 2.5% and 17.5% of the investment value).
Advantages: Flexibility. You decide where to invest your money and you choose your own income level.
Disadvantages: You carry the risk of poor market performance—no guarantees. There is a risk of outliving your money. This is the risk of living much longer than expected and drawing too much income early on.
Investing in a Retirement Account
Investing in a retirement account isn't a onetime decision. It's more like a process. At a single point in time, a decision is made to invest money in a certain way, but as time moves forward, balancing that retirement account becomes important too.
Keeping an Account in Balance
What is meant by keeping an account in balance? Balance is all about understanding, accepting, and controlling risk. Most individual investors attempt to control risk by diversifying the asset mix in their investment portfolio.
A diverse retirement account might consist of a mix of stocks, bonds, and perhaps a fixed-income fund such as a money market account. Even within these three broad categories, there are subcategories of investments. For example, the portfolio might include foreign and domestic stocks, or long and short-term bonds.
Out of Balance Accounts
Overall, there are two reasons why a retirement account can get out of balance. It's important to understand both concepts so you know what you need to do to bring your accounts back into balance. The two most important factors are:
- Investment Performance
- Risk Profiles
The asset allocation of most actively-funded retirement accounts is affected by two forces. The first has to do with the performance of each asset type, and the second has to do with new funds added to the account over time. Each of these factors will influence the total funds in each asset class. However, the account holder has very little influence over the performance of each asset class relative to one another.
Unless all of the investments are in a single asset class, each asset's return on investment will grow in a way that influences the overall asset mix or allocation.
Individual Risk Profiles
The second dynamic driving the need to revisit a retirement account's asset allocation has to do with individual risk profiles. Admittedly, the amount of risk an individual is willing to accept will vary from investor to investor. The most common example includes the risk associated with retirement accounts as the retiree starts to depend on those funds for income.
When the account holder was younger, they were willing to accept more risk with the hope of higher returns. On the other hand, an investor that plans to use their retirement fund as a reliable source of income might not be comfortable with a large decline in their portfolio's value; even for a short period of time. This investor's individual risk profile would be very different than someone that doesn't need to withdraw money from the account for 20 or 30 years.
Re-balancing a Retirement Account
To achieve this objective, the investor has only two choices:
- Make direct adjustments to each asset class by reallocating funds from one class to another.
- Use new investments placed in the portfolio to bring the account back into balance.
The first option, making direct adjustments and reallocating funds, is the more disruptive of the two choices. This particular option may be the best choice in cases where the investor has ignored an account for quite some time, and it is severely out of balance, or an event has caused their risk profile to change dramatically.
The second option allows the investor to slowly bring their retirement account back to an acceptable balance by allocating new funds in a way such that under-funded asset classes are provided with more money over time. In fact, the ideal way for an investor to keep their account in balance is by making new investments that are aligned with their portfolio's overall objective. This concept is one of constant re-balancing.
How to Build a Balanced Retirement Portfolio
Original post by Colleen Reinhart of Demand Media
Building your retirement nest egg can be a stressful balancing act. On one hand, you need your portfolio's growth to be aggressive enough so you have enough to retire when you choose. On the other hand, the fastest-growing investments are generally the riskiest, and you don't want to be left destitute by an unexpected market tumble. No single mix of investments is right for everyone. What defines "balanced" for you depends on a number of factors, including your age and your tolerance for losing some of that hard-earned cash.
Adjust your portfolio holdings based on your age and your current assets. The classic balanced portfolio model suggests putting 60 percent of your savings in stocks, 30 percent in bonds and holding 10 percent in cash. If you're younger, you can push your stock holdings a little higher. The same advice goes if you have a large existing portfolio. On the other hand, people age 50 and over should scale back their stock holdings to about 50 percent, since they have less room for loss as they near retirement.
Calculate your expected sources of retirement income, other than what you'll get from your investments. Knowing this number helps you determine how much you'll need to lean on personal savings during your golden years. If it turns out you need high growth to get the standard of living you want, you may find yourself more tolerant of investment risk. Add up the value of your pension, your home, Social Security payments and anticipated part-time income.
Calculate your anticipated retirement allowance, based on the growth you can expect from your holdings. If you're not sure how to calculate what stocks, mutual funds and other non-fixed income investments will earn, use past growth reports to arrive at accurate estimates. Add your savings to your other expected retirement income sources, then divide by the number of years you expect to be retired.
Reallocate your portfolio funds based on your risk tolerance. If the annual allowance you calculated doesn't look like enough for you, you have two options: invest more aggressively, shifting more of your savings to stocks, or save a higher percentage of your income each year. A third option, of course, would be a combination of these strategies. If you're mid-career and wary of stocks, you can get away with holding only 50 percent of your portfolio in stock if you put more of your paycheck into savings -- 20 to 30 percent, depending on your income and savings goals.
Invest your money wisely by choosing relatively low-risk forms of each investment type for your portfolio. To mitigate risk from holding bonds, stick with investments with maturities of three years or less, and choose reliable bonds unlikely to default, such as U.S. Treasuries or reputable corporate bonds. Pick stocks that pay out dividends, since these investments tend to be less volatile.
Evaluate your retirement portfolio's fund distribution at least once annually, and make adjustments as you age or as your goals change. Scale back your stock holdings as you near retirement, and consider using a portion of your savings to buy a life annuity, which will guarantee you a specific income for the rest of your retirement years.
Sources from which the information in this module has come
If you don’t need additional income to supplement your retirement funds
While this may look like an ideal situation, and you can spend your time and energy as you wish, it does bring with it the problem of boredom. To have made the money you did, you had to be hard working and driven - and to suddenly have nothing to do is a shock to the system. Golf is a wonderful leisure activity but even driving your handicap down doesn't fire up the juices like a good business deal or a life-changing intervention in a charity or NGO.
In the preparation for the Journey you looked at what gives meaning and purpose to your (retirement) life. Have a look at that again and in a few key words describe your Dream (your Elevator Pitch to yourself).
If you do need additional income to supplement your retirement funds
First and foremost, get advice and guidance from a Financial Advisor! He/she will help you identify how much you need to do the things you want to do.
Use existing skills to start again, or integrate your wisdom into starting a new career or starting your own business. You can decide what income you need to generate each month, you can keep tight control on your expenses because you don’t have the expenses that young families have, and you can decide if you want to provide your service part-time or full time. (Don’t use your pension to fund this business!)
Many people decide that they would like to do consulting work when they retire. For some this is a viable option, for most it is very difficult to get the second piece of consulting work (the first is normally with your current employer – but that doesn’t last forever.)
Why not let your imagination run free? A colleague become a Bee Keeper – it generated a little income from the sale of honey, but hiring out his hives to fruit farmers was very profitable. What about a movie extra or an advertising model (they are not all young, tall and tanned). What about a guide at the local brewery, a specialist public speaker, the coach of a local sport team (maybe not paying straight away, but once you’ve demonstrated how good you are ...?)
Many people in retirement take on a Mentoring role – most often with younger people in the Company they have just left. In preparing for this Journey you looked at the skills needed to be an effective Mentor.
An area to consider is in Mentoring young Entrepreneurs. They started their business because it was something they were passionate about but it is easy to get swamped by the detail and administration required of a young business. You may be able to provide specific advice and experience related to the business – but just as valuable is to provide guidance on the basic principles of sound business practice.
You may be able to provide that Mentoring role free of charge, but if you are looking to supplement your pension with a Mentoring fee, consider a delayed payment scheme of some sort. In the early life of a business cashflow is KING and the business owner may not be able to afford your Mentoring – even though his/her need may be great. So arrange a fee at your going rate plus an escalation for inflation – but payable in 10 years time. You probably don't need the money now, but it would be most welcome later. And if your Mentoring has been any good the business should have survived those 10 years and can now afford to pay you.
However the rules are changing around Mentoring. If you haven't already done so, take a look at these Mentoring guidelines.
A good and safe option for a retirement income generator is Network Marketing. There are many products you could choose; Amway, Aloe Vera, Herbalife and one that is particularly well supported is Mangosteen, a health juice. The value of Network Marketing is that all the admin, marketing, product development and sales procedures have been developed for you – but it does require your time and effort in selling the product.
Many countries have Talent Exchanges – where people trade their talents (their skills and knowledge) for goods and services that they require. Talent Exchanges hold their value and are not impacted by devaluations and inflation.
Before you start spending money you need to be clear about what it is you want to do and why someone else will pay good money for it. There are a number of worksheets you need to complete to clarify your intention.
The 4 Worksheets in this analysis will give you a clear indication of what you are wanting to do and will give you a starting point for making it happen. Strategic Analysis worksheet.
Get the details of an Entrepreneur Incubator in your area – you may be able to get on a support programme that helps you manage the process of starting your own business and could result in creating valuable connections.
It is important to be realistic about your chances of success. Most small businesses fail within the 1st 3 years – so be sure about what you are offering before you start to spend money on making it happen.
Discussion Assignment – My Financial Health
If your time is yours to pursue your passion without the necessity of generating additional income,
Describe your Vision for what it is you want to create.
If you intend to generate an income through some form of business venture,
Describe your Vision for what it is you want to create.
This Assignment is an excellent opportunity to get feedback from others before you spend a bundle of cash on something that might not be viable.Discussion Forum
Next module : My Social Health
Loneliness is a killer! What do you have to do to build your relationships with friends and family?Next Module