It’s common knowledge that very few people reach retirement age with sufficient capital saved to maintain their pre-retirement lifestyle. There are several reasons for this shortfall including insufficient reserves, decreasing returns on investments and an increase in longevity. All three factors combine to restrict the income earning ability of seniors after retirement.
The longer you live, the more capital you will need to fund a retirement income. Currently statistics reveal that the life expectancy of an average male and female aged 65 respectively is 19 years and 22 years; a lot longer than we have been led to believe.
Our life expectancy reduces as we grow older but will never reduce to zero and, the average 85 year old has a life expectancy of seven years.
The more information known about the individual, the more accurate the life expectancy calculation will be. The lifestyle and medical situation of a retiree plays a significant role. Thus, a 65 year old male who:
- Smokes, earns R5 000 a month, works as a cashier and has mild medical conditions has a life expectancy of 11 years.
- Has never smoked, earns R50 000 a month, works as an accountant and has not been diagnosed with any medical conditions has a life expectancy of 23 years.
Many people forget that this expectancy is the average, which means that both 65 year olds have a 50% chance of living beyond their life expectancy.
It is therefore critical that your financial adviser takes these longevity factors into account when projecting your retirement capital and income requirements. If life expectancy is not included in the calculation, you cannot determine what income needs to be sustained for the rest of your life.
To forecast an accurate life expectancy is difficult. All insurers – other than Paramount Life – only look at age and gender when determining life expectancy.
In the table alongside I’ve tabulated a few retirement scenarios to determine the effect of different escalations and how this affects retirement capital.
For a 65 year old (healthy male, accountant, earning R50 000 per month, non-smoker) who wishes to start with an income of R10 000 per month, the capital required will vary according to his income escalation expectation.
It’s worth noting the extra capital required to give you an increasing income. Always be aware that the capital required increases exponentially as your income escalations increase. This has significant implications if you are 65 and have to pay a retirement village levy of R2 000 pm.
Considering most retirement village units are priced around R1 million, it’s essential to factor in that a 65 year old retiree will need to invest as much as 60% of the purchase price just to cover the levy. The only way to reduce this cost, and remove risk, is to purchase a guaranteed annuity which takes into account your medical and lifestyle condition.
It is crucial that above inflation returns are achieved. One needs to take into account fees ranging between 1% to 2% of the return and try to target somewhere between 3% to 4% above inflation.
At retirement you currently have two options when exiting a pension fund or retirement annuity:
- Guaranteed Annuity. These are calculated by the actuaries at a life assurer. All the risks of the ‘expected not occurring’ are for their account.
- Living Annuity. The annuitant makes the call and all the risks of the ‘expected not occurring’ are for their account.
The importance of your personal longevity expected income escalations and expected investment returns should never be underestimated.
Whilst it’s difficult to recommend a fixed annuity at this stage, as interest rates are so low, Paramount Life certainly has the edge with their underwriting methods. Those whose life expectancy is shorter may be well advised to compare the annuity Paramount Life offers, to even a living annuity, where the member takes all the risk.