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RETIREMENT: A QUESTION OF TIME BRUCE CAMERON EDITOR: PERSONAL FINANCE.

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Presentation on theme: "RETIREMENT: A QUESTION OF TIME BRUCE CAMERON EDITOR: PERSONAL FINANCE."— Presentation transcript:

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2 RETIREMENT: A QUESTION OF TIME BRUCE CAMERON EDITOR: PERSONAL FINANCE

3 Agenda Why you need to plan How much you need Long-term savings choices Pension choices The risks you face The need for advice

4 Reasons to plan What you need, why you need it and how long it will take Taking account of the threats: Inflation, investment market returns/volatility and living too long Finding the products that will generate enough capital to provide a sustainable income in retirement Taking account of risk you can and cannot take (when you have insufficient capital) in your asset class and asset management choice While minimising taxation And planning your estate.

5 No plan: You become a statistic Only 26% of retirement fund members will reach retirement financially secure To achieve a financially secure retirement you need to save at least 13 cents of every rand you earn in your life Most fund members contribute between five and six cents of every rand they earn Average period of contribution: 27 years and six months – instead of 40 to 45 years Most people go into retirement with a pension equal to 28% of their last pensionable pay cheque

6 Planning: A matter of options Retirement funding is deciding what pleasure you will forgo now to have some pleasure in retirement Too little saved = Poverty in retirement Retire early = less in retirement Live too long = Depletion of cash Too much saved = Unnecessary sacrifices before retirement

7 The Build Up: Calculating how much you need It is not a quick calculation: Capital amount of 10 x annual income is Not Enough It will be closer to 15 to 20 x annual income You need to start at the end, not the beginning Your lifestyle in retirement Your age at retirement A sustainable income in retirement Capital required to generate a sustainable income Type of annuity (pension) – this is variable

8 The Build Up: Tax-Incentivised Retirement Savings Vehicles Occupational Retirement Funds (mainly sponsored by employers): Defined Benefit Funds Defined Contribution Pension Funds Defined Contribution Provident Funds Umbrella Funds Individual vehicles: Retirement Annuity Funds Preservation Funds (Pension & Provident)

9 Occupational Funds Defined benefit funds: Contributions up to N$ a year deductible from taxable income You know what you will get (Final salary x years of membership x a factor) No investment risk for you Must use two thirds to purchase a pension – subject to income tax at marginal rate Lump sum tax free Defined contribution pension funds Contributions up to N$ a year deductible from taxable income Contributions by your employer and yourself defined No benefit guaranteed - Investment risk all yours Must use two thirds to purchase a pension – subject to income tax at marginal rate Lump sum tax free

10 Dangers of Occupational Funds Mind the Gap: No employer sponsored scheme is sufficient. Most funds aim to provide % of pensionable income after 40 years of employment. Contributions based on pensionable income: Final salary excludes all allowances Big gap for dependants/disabled: Beware DC funds when you are younger. You need more life assurance. Most DC funds only have assurance cover of between 2 and 3 times annual pensionable income

11 Retirement Annuity Funds Legal structure: Contributions up to N$ a year tax deductible Must use two thirds to purchase a pension – subject to income tax at marginal rate Lump sum tax free May only be matured at age 55 or older. Product choices Life assurance: Normally contractual with penalties for reducing or stopping payments. Warnings: Higher cost and long-term contracts (based on commission). Linked Investment Services Product: Greater investment choice. Non-contractual but can be costly. Unit trust: Choice limited to the management company. Non- contractual. Costs will depend on asset management house Individual Retirement Funds

12 Individual Funds Preservation Funds Legal structure: Amounts transferred from occupational funds No new contributions Preserves tax status of previous fund (pension or preservation). Product choices Life assurance: Normally contractual with penalties for reducing or stopping payments. Higher cost. Linked Investment Product: Greater investment choice. Non- contractual but can be costly. Unit trust: Choice limited to the management company. Non- contractual. Costs will depend on management company

13 Before and at retirement Decisions must be made on annuity (pension). Annuity choices are: Fund-provided pension : normally a defined benefit occupational fund Or Voluntary purchase annuity (VPA): pension bought with after- tax money, including discretionary savings and proceeds of a provident fund. Or Compulsory purchase annuity (CPA): pension bought with proceeds of a tax-incentivised occupational pension fund or retirement annuity fund

14 Main CPA choices Guaranteed life annuity: a life assurance company guarantees you will be paid a pre-determined pension for life (level, escalating, capital guarantee, joint and survivorship options). Pension depends on gender, age, interest rates, guarantees and product. Dies with you (depending on guarantees). And/or With profit annuity: a life assurer guarantees you will be paid a minimum pension for life but increases will be dependent on investment returns. Dies with you. Only available in Namibia through an occupational fund And/or Investment-linked living annuity (ILLA): you take the risk of ensuring that you will have a sustainable pension for the rest of you life. Must drawdown between 5 and 20 percent. Lives after you.

15 Main threats to a financially secure retirement 1.Not planning holistically (with proper advice) 2.Starting to save too late 3.Not saving enough 4.Withdrawing savings before retirement 5.Retiring too early 6.Inflation 7.Costs 8.Tax 9.Investment choices 10.Product choices 11.Living too long 12.Dying too soon 13.Choosing the wrong annuity 14.Advice Risk

16 1. Not planning holistically Finances are a balancing act which require: Taking some risks yourself and sharing others with others. Deferring spending (saving) Taking account of affordability (debt) Best solution: A financial needs analysis With regular check ups, particularly when circumstances change

17 2. Starting to save too late Assuming a regular savings pattern every N$100 in pension income you receive in retirement, N$65 will be from money you saved (with the investment returns) before the age of 45. Percentage of income required at different ages for a 75 percent NRR: Current Age Targeted Retirement Age % 7% 6% 30 16% 12% 8% 35 22% 15% 11% 40 32% 20% 14% 50 51% 48% 27%55 103% 44% Assumptions: Target 75% of final annual salary with a 3% real return Source: Sam Robson, Glenrand MIB

18 3. Not saving enough Don’t mistake high income with high net wealth Save below the required minimums and you will not achieve your target Save less at the beginning and you need to save a lot more at the end

19 4. Withdrawing savings before retirement Alexander Forbes research shows that after 40 years of potential fund membership: 12 percent of fund members reach retirement with an NRR of more than 75 percent; Seven percent of fund members have an NRR of between 60 and 75 percent; 10 percent of fund members have an NRR of between 45 and 60 percent; 14 percent have an NRR of between 30 and 45 percent; and 57 percent of retirement fund members have an NRR of less than 30 percent of their final pay cheque One cause: Non-preservation reduces potential NRRs of 75 percent by between 15 and 24 percent

20 Non-Preservation

21 Non-preservation A problem in Namibia as well Total amount of withdrawals not preserved during 2009 was N$775,791,577 ( Source: Namfisa) One fund manager indicated only 87 of 876 withdrawing members transferred benefits to its preservation fund. 92% made partial or total withdrawals. (Source: C. Schlettwein Deputy Minister of Finance Statistics)

22 5. Retiring too early Replacement ratios:Retirement Age NowAge % 50.4% 29.1% 12.5% % 54.4% 31.8% 14.3% % 58.7% 34.8% 16.2% % 63.5% 38.1% 18.3% % 68.6% 41.6% 20.7% % 74.1% 45.5% 23.2%

23 6. Inflation Inflation and being too conservative: R1 000 a month X 480 months = N$ Average annual return of 8% = N$ Average annual inflation of 10% = N$ SO: The buying power is R Note: Inflation of 4.5% will reduce a fixed pension by 25% every six years Inflation of 7% will halve a fixed pension every 10 years

24 Assumptions: Inflation at 4.5 %. Drawdown 6 percent% How you need to counter inflation:

25 7. Costs Percentage points seem low : Every one percentage point saved in costs will improve your end benefit by 20% over 40 years Rusconi's 2004 research on retirement saving vehicles: - Most cost-effective is a larger occupational retirement fund. - RA with unit trust funds sold will be reduce end benefit by between 22.3 and 32.5 percent over 40 years. - Life assurance RA will reduce benefit by between 30.8 and 44.7 percent over 40 years..

26 They just nibble away

27 8. Tax: Incentivised retirement products Income tax: (EET) for pension funds and RA funds: Exempt from income tax: Aggregate of N$ for contributions to all retirement funds Exempt from income tax: Investment returns Taxed: Pension as and when received: -Lump sum: Tax free. -Pension: Taxed at marginal rate Big Advantage : Deferred tax on balance of capital

28 Tax: The simplified N$ problem Annual IncomeTax Deductible Tax Incentive Capital NRR on N$ Additional Capital Pension Required Additional NRR N$ N$40 000R1.6m75%N$ N$ N$40 000R1.6m50%N$ N$ % N$ N$40 000R1.6m40%N$1.4mN$ % NS1 mN$40 000R1.6m20%N$4.4N$ % Assumption: 15% of taxable income for 40 years = 75%NRR

29 8. Tax: Non-incentivised savings products Life assurance products: Income tax: In hands of insurer No exemptions apply Collective Investment Schemes: (Conduit principle) Your marginal rate after exemptions

30 9. Investment Choices (Saving & Dis-saving) Some facts of life: The best tax free guaranteed return you can get is paying off your debt The cheapest equity investment is in Exchange Traded Funds (and in the long term you may probably do better) Diversity of investments is the proven best solution Exceptional promises of returns come with inordinately high risks – If it sounds too good to be true, it will be too good to be true

31 Investment Choices – Reg 28 Prudential regulation: Dictates how much you can invest in asset classes and sub-sectors Aims at diversity of investment But: Does not force you into a low yielding portfolio Applies to tax-incentivised retirement savings (by law) and investment linked living annuities (by industry agreement)

32 Investment Choices – Danger lurks Masterbond FundsTrust Supreme Holdings Fedsure Saambou Bank Fedbond Leaderguard (Currency speculation) Pyramids (Rainbow, Kobus Mil, Madoff) Publiserv medical scheme Insider trading Alexander Forbes (Secret profits) Life assurance confiscatory penalties Unregistered money market funds (Ovation: Common Cents, CMM) Fidentia Property syndications/fractional ownership (BlueZone/Sharemax)

33 That Balancing Act again Inflation versus returns Greed versus fear Costs versus returns Tax versus tax Risk versus returns Too conservative versus too aggressive Passive versus active

34 And you cannot rely on averages Assuming constant real after-inflation returns is dangerous for: -People planning for retirement -For pensioners living off an investment linked living annuity It all depends where you are in the cycle: Example: Fund member 10 years from retirement: 1998 retiree: NRR of 8x pensionable salary 2008 retiree: NRR of 14x pensionable salary (Source: Daniel Wessels)

35 You cannot combat fate Volatile markets

36 9. And your NRR will vary Assumptions: Source: Simeka Employee Benefits 1.Join age 35 2.Contribute 13% of salary RetirementAge Investment Return CPI+5%39%49%56% CPI+6%46%58%67% CPI+7%54%69%82%

37 10. Product Choices -Guaranteed versus no guarantees -Capital guaranteed index linked (synthetic) versus life guaranteed product (non-synthetic) -Contractual (life assurance RA) versus non- contractual (Unit trust RA) -Limited underlying investment choice (single balanced/flexible portfolio) versus wide investment choice (multiple funds) -High profile brand (often higher cost) versus low profile brand Warning: Only invest when you understand all – There is no such thing as silly question

38 11. Living too long Many pension plans based on a 65-year-old dying at 84 but 50% live longer One person in a couple aged 65 has a 52% chance of reaching age 90 A living annuity with a 3% average real annual growth and 5% drawdown has a 25% chance of lasting until age 90 First person to live to 150 is already 50 years old

39 12. Dying too soon (pre-retirement) Most South Africans will die before age 50 – but not PPS members… unless… Your chances of being involved in a motor accident are one in ten 80 percent of retirement fund member beneficiaries receive less than 50 percent of what they require Most South Africans are under-insured Insurance is there to ensure that there is sufficient when life deals you a bad hand. But it is a continual balancing act… Too much insurance = you go without Too little insurance = you and your dependants go without

40 Dying too soon A child is born Saving target R in 18 years You die after 10 years You have only saved R You need to cover the risk But say you die after 15 years and investment markets have been good: You only need R You are still insured for R

41 Dying too soon Health warnings: Life assurance is not to make dependants rich – that will make you poor while you live Compare premiums But cheap assurance can be expensive (watch the premium guarantees) Be on with the new love before you are off with the old (apologies to Will Shakespeare) Remember you have group life assurance Be cautious of accident and big toe assurance Always confess to the dickey heart and weekend sky diving

42 13. Choosing the wrong annuity Once you purchase a guaranteed annuity, you are locked into that annuity for life - life assurance guarantee is calculated using your average expected life span and the prevailing long-term interest rates Do not have to buy a single annuity with all your retirement capital: –split annuity derived from the same source –Interest rates: the higher the rate the sooner to consider locking in - the lower the rate the later. Age: the older you are the better the yield – taking account of interest rates optimum time from age 70

43 The older you are the better it gets Male buys a level annuity with R1 million - implied yields are: Age 55: R a year % implied yield Age 60: R a year % implied yield Age 70: R a year % implied yield Age 80: R a year % implied yield Age 85: R a year % implied yield (An implied yield is the annuity (pension) divided by R1m expressed as a percentage)

44 14. Advice Nearly everyone needs financial advice – but it can be a double-edged sword: No advice and you may not get the balance right and make wrong investment decisions. Bad commission-driven advice and you will not get the balance right

45 Getting the right advice Consider dealing with an organisation, such as a financial advice company or network, rather than a one-person operation. Organisation should have a competent team Beware of what are called broker funds, often used to charge extra fees Best-qualified advisers have a certified financial planner accreditation from the Financial Planning Institute (www.fpi.co.za)www.fpi.co.za Pay for it – preferably a fee for advice – not a commission for product

46 What a good adviser should do Provide an annual projection to show if you are on track with your NRR _If not how much more you need to save and/or whether you must change your projected retirement date. Provide an annual death benefit needs analysis that shows the level of death benefits required for your dependants to be provided with sufficient income. Provide an annual needs analysis of your requirements for inco0me replacement in case you are unable to work Tell you how your financial security in retirement will be affected if you do not preserve your retirement savings if you leave the fund before retirement. Tell you, long before your date of retirement, what pension you can expect based on actual quotations from the market (showing pensions under different options). Tell you if your investment options are inappropriate. For example, you may have chosen a cash portfolio while you are relatively young or have switched to a high-risk investment in the hope of earning better returns, particularly when you are close to retirement or in retirement.

47 Questions Before I retire……

48 Q & A

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