May You Live Long… But Not Too Long

“Live long and prosper” (Vulcan salutation from Star Trek)

One of the biggest risks that retirees face today is outliving their savings. Thanks to medical advances, we are all living healthier, longer lives. But we have to appreciate what that means for our money.

In the not-so-distant past, retiring at 65 meant that you probably needed to have enough put away to last you another 20 years, since living beyond 85 was uncommon. These days, however, living to 100 is no longer so rare. That means that retirees need to think about their money lasting for at least 35 years after they stop working.

Part of the problem, of course, is that nobody knows for how long they will actually live. If they did, planning for retirement would be a lot easier. As it is, it requires considering risks and probabilities and managing them as well as possible.

Living annuities

Most South Africans entering retirement today choose to put their money into a living annuity. This is a product that provides a lot of investment flexibility and the ability to choose how much income you take out.

These are very useful tools, but, unfortunately, they are often used for the wrong reasons. The biggest mistake that many people make is to use a living annuity because they want a higher income to start with.

This may be great for the first few years, but the more you take out at the beginning, the less you will have later on. If you do live longer, you can find that your income starts to fall off dramatically in later years. This leaves you with less to live off, often at a time when your medical costs are going up.

Four Solutions

There are four ways that you could deal with longevity risk.

1. The most obvious, but often the most difficult, is to save more to start with. The more savings you have built up, the higher your starting income can be, and the longer it will last.
   
   
2. If you are unable to do that, or you are already at retirement age, the flip-side of that coin is to draw a lower income from your living annuity. This can also be difficult, and require some lifestyle changes, but the less you draw from your retirement capital, the longer it will last you.
   
   
3. It’s also worth remembering that living annuities are not the only option in retirement. You could use your savings to buy a guaranteed annuity (often referred to confusingly as a “life” or “traditional” annuity) from an insurance company. These will pay you an agreed pension until your death. Depending on the type of guaranteed annuity you choose (it can be structured in a variety of formats), this may mean taking a lower income to start with, and you also won’t be able to leave anything to your heirs. However, it can (again, depending on the type of guaranteed annuity you choose) completely rule out the possibility that you will run out of money while you are still alive.
   
   
4. The drawbacks of guaranteed annuities can however make them unattractive on their own. An increasingly popular option is therefore to take a hybrid approach. This means using some of your retirement savings to buy a guaranteed annuity, and some for a living annuity. Over time, you may even switch more from the living annuity into guaranteed products, as these become cheaper as you get older.
   
   While it won’t be right for everyone, research shows that this hybrid approach can reduce many of the risks in retirement. It can decrease the effects of inflation and stock market volatility, and improve your chances of leaving a legacy.
   
   It can also significantly bring down the chance that you will outlive your money.

To discuss your options for funding your retirement, speak to your financial adviser.