When we reach retirement, most of us have to choose between maintaining our lavish lifestyles and thereby possibly facing financial ruin before too long or alternatively lowering our lifestyles in order to preserve our capital for longer. The problem is, we don’t know how long we are going to live and with modern medical cures and procedures on offer, we are probably going to live longer than we had expected.
Once we are no longer earning an active income, the more income we draw and spend in the early stages of retirement, the less we will have available to sustain the value of our nest egg later on and this could meand that it could run out! In inflationary environments, it becomes paramount to continue to grow our capital and therefore also our annuity income throughout retirement, so as to retain one’s purchasing power.
In a living annuity, legislation allows annuitants to draw between 2.5% and 17.5% of their capital per annum. The latter is extremely high and is not sustainable over any period of time unless one’s investment returns are phenomenal!
The point is this: Capital preservation is dependent upon two variables: the total return (both capital gain as well as income earned) achieved and the rate at which income is drawn from the annuity. In essence, the total returns achieved during retirement need to exceed the rate of growth of required income by at least the inflation rate in order for the income received (annuity) to keep pace with the ever-increasing cost of living. The larger the outperformance of the portfolio vs the required income growth, the more one’s portfolio will grow in real terms, meaning that later on in retirement one will be able to increase one’s income level to even higher than the inflation rate. This may be required due to the increased likelihood of having to undergo expensive medical procedures and treatments (the cost of these tends to increase much faster than inflation).
Now, in order to achieve the desired total return for a specific retiree’s circumstances, a detailed analysis is required by a qualified financial planner. Ideally, the financial planner should not place the retiree’s capital in investments which offer extreme volatility unless the capital is large enough to withstand such risk of loss. Most of us do not have nest eggs which far exceed that amount required to sustain our lifestyles.
For that reason, in most cases, annuity funding portfolios are invested in more conservative assets than would have been the case earlier in the retiree’s life. This means that they will not grow as fast as they might have had they been more aggressively invested. This then has the result that it is almost impossible to make up for lost ground once in retirement. In other words, if you have not saved up enough of a nest egg before going on retirement, you are not going to be able to catch up without taking undue risks. Risks which have potentially dire consequences.
The bottom line is this:
Save early and as much as you can
Spend less than your retirement portfolio generates especially in the first several years of retirement
Increase your income annually in line with inflation if able to
Investors need to examine their personal financial circumstances very carefully before deciding to eat into their retirement capital to supplement their income. Rather bite the bullet in the beginning and reap the benefits of that discipline later on. This is often very difficult, however, it is preferable to finding out that one’s capital has been irreparably eroded causing one to seek financial assistance from one’s children or having to try to look for the odd job to earn a few extra pennies.