This is the eighth in a 10-part series on how to structure your life-time finances. The series has been prepared by Personal Finance in conjunction with Old Mutual
One day you could be the king pin holding together the works. The next day you do not even get invited to the office party. That day can be retirement day.
It can be quite traumatic.
But the sackful of money you hopefully will receive on retirement should keep you busy for a while.
Last week I dealt with the taxation of your retirement benefits. This week it is the turn of investment. The investment of your retirement funds is critical. You must follow a number of steps:
Step One: Assess Your Lifestyle
By now you should have decided what you want to do with your retirement, which does not necessarily mean lying around at home watching videos. Most people when they retire are capable of moving into other jobs or starting their own businesses. Many who have low retirement savings have no choice - they have to find another source of income.
However there are savings you can effect. For example, if you have no children living at home consider moving into smaller accommodation. If you do move take account of the property market and pick a time when it's rising.
Step Two: Assess Your Needs
The amount of money you receive in retirement benefits, particularly if you are on a defined contribution scheme where all your benefits are paid out as a lump sum, seems to be a lot of money. In many cases it is not. You could still have more than 1 560 pay days ahead of you - the difference now is that the pay master is yourself.
You have to be sure that you will have sufficient money to live on whether you live for 10 years or 40 years after retirement. So not only do you have to decide on how much you need to live on each month, you also have to take bets with yourself about how long you are going to live.
In deciding how much you need, remember your daily costs will probably have dropped. There is no need to dress up for work. Your transport costs will diminish. You will be paying less tax. You will not be contributing to a retirement fund except possibly to a retirement annuity (more of this later).
Then you need to take a guess at what inflation is going to average in the future. The figure you have worked out for your first year of retirement has to be escalated by the inflation rate every year if you are not going to become progressively poorer. And remember as you get older your medical expenses are likely to increase.
Step Three: Assess Your Risk Profile
The next vital step is to assess your investment risk - to work out your ability to be able to accept a loss of your capital. Many people on fixed incomes, particularly when they are struggling to make ends meet, take risks by putting their money in investments which promise high rewards but fail to deliver. Masterbond is an example. Another is the current craze of extremely high risk "get-poor-quickly" schemes. Rather live poorer than destitute and seek ways to earn extra income.
Step four: The Right Investments
The trick now is to choose the right investments that will provide you with an income while keeping your capital intact and growing long enough to provide an inflation-protected income until you die. As most of us don't know when we are going to die, the best bet is to lay off the bet. Let someone take the gamble for you. And fortunately for us there are people willing to take that gamble in the life assurance industry or the so-called product factories. The basic instrument is an "annuity" or in more common parlance a regular pension payment.
If you are a member of a defined benefit or a defined contribution pension scheme, or have a maturing retirement annuity, the bet is made for you as two-thirds of your pension benefits must be paid as a regular annuity. These are known as "compulsory" annuities.
When you buy a "voluntary" annuity you invest a lump sum, against which you are provided with a monthly pension. The risk of ensuring that you receive an income until you die now lies with the annuity provider. If you die early you lose, as in most cases you get no money back. If you live to a very ripe old age you score.
Voluntary annuities take different forms:
* Fixed period annuities: You decide on the term of the annuity, say 10 years. You can chose a lower annuity with capital back at the end of the period, or a higher annuity with no capital back;
* A level annuity: You receive the same amount every month until you die. There is no residue for your estate;
* An inflation linked annuity: You receive less at the start than you would with a level annuity but the payments will increase in line with inflation or at a selected rate, for example 10 percent. There is no residue for your estate.
* A joint survivorship annuity: This annuity will be paid until who ever dies last, you or your partner. You receive less for your money than a level annuity and there would be no residue for your estate.
* Living annuities: These were first introduced by the product factories for people who wanted a residue for their heirs. You will receive a far lower pension than you would have received with a level annuity. With a living annuity you can select an income between five and 20 percent of your capital. Beware that if you draw an income at higher rate than the rate of growth of the investment you could fall short. Generally this annuity is for the wealthier.
You can also buy an annuity with part of your money and invest the balance in a capital guaranteed product or a low risk unit trust that gives untaxed capital growth.
The lower your income the better advised you are to buy an inflation-linked annuity with a joint survivorship clause if you are married. The wealthier you are the greater the opportunity to mix and match.
Reduce your tax liability
If you do not need to use all of your capital immediately for income here are a few ways to reduce your tax liability.
Use part of your lump sum towards purchasing a single premium retirement annuity. You are allowed to claim an amount equal to 15 percent of your annual non-retirement taxable income if you invest the money in a retirement annuity.
If you need significant medical treatment, such as dental surgery, have it done before you retire as, depending on what you earn, you can claim a portion back against tax. This only applies to amounts not payable by a medical aid scheme.