Question:
Hi there, I have ongoing health issues relating to my back and after two mayor operations , I still have so much pain that I cant effectively attend to my daily responsibilities as an auditor . Im also travelling alot localy and abroad which is not helping my current health situation. I have contributed to a pension fund and a provident fund for the past 25 years and will be turing 52 in February 2015. I have learned that in terms of our company's insurance policy for disability, I will not qualify for disability benefits as pain is apparantly not considered to be a disability. In view of this, I was thinking of taking early retirement due to ill health and to start my own practice on a scale that would suit my current medical situation. According to the the rules of our pension fund , this is apparantly allowed but I need the consent of the Pension Fund trustees for this. Is this possible in terms of current legislation? If athorisation for early retirement is granted, will all the rules in terms of normal retirement be applicable? What are the issues that I should take into account if I want to go on early retirement? What should be considered when buying an annuity? Looking forward in hearing from you. Regards, Danie
Answer:
Danie,
You are allowed to take early retirement, if your fund trustees permit this. Remember that you can withdraw from these funds at any time, on resigning from your employer. However, if you take early retirement, then yes, the rules pertaining to "retirement" will apply. This means you will qualify for a lower rate of tax on your lump sum but also that you will be required to buy an annuity with at least two-thirds of your pension fund proceeds. Or you can use your entire proceeds, to buy an annuity. The annuity will provide you with a regular income stream for the rest of your life.
You are not permitted to buy a fixed-term annuity that only pays out for a specific number of years. Your annuity income is taxed according to the personal income tax tables prevailing at the time. You can choose between two types of annuities: a Guaranteed Annuity or a Living Annuity.
1. The Guaranteed Annuity (GA) is an insurance product (policy). It provides you with a specified monthly pension for the rest of your life. You must purchase this annuity from a life assurance company, which effectively insures you against longevity risk (the risk that you live longer than expected) as well as investment risk (earning insufficient return on your capital to pay your pension). The full pension is paid until you die. The drawback is that your capital dies with you, and no money passes onto your heirs. That is your risk: you (or, rather, your heirs) forfeit your savings in the event that you die sooner than expected (unless a guarantee or life assurance is built into the contract).
Annuity rates (the pension that you receive) are variable and can differ from one life assurance company to the next. As you may receive a different income for the same amount invested, you should shop around for the best available rate at the time. Life assurance companies consider a number of factors in determining your annuity rate: 1. Your age: the younger you are, the longer you are likely to live, and hence the lower your monthly pay-out. 2. Your gender: women have a higher life expectancy than men, on average, and therefore receive a lower pension. 3. Interest rates: the higher the prevailing interest rates, the higher your monthly pension is likely to be 4. Your choice of annuity: you have a number of product options, with different risk profiles. The more insurance you require, the lower your annuity will be.
Guaranteed Annuity products:
i. Level or fixed annuity: You receive the same amount every month for the rest of your life. This means that your income does not insure you against inflation; the purchasing power of your annuity (and hence your standard of living) will thus gradually decline.
ii. Escalating or variable annuity: This annuity increases annually, either by a fixed amount, or in line with a pre-determined inflation index, such as the Consumer Price Index (CPI). An escalating or inflation-linked annuity will pay out less than a level annuity initially, but will maintain its purchasing power and thus gradually overtake the fixed annuity in value.
iii. Guaranteed and then for life annuity: This annuity will pay out less than the first two, as it insures you against the risk that you die soon after retiring and thus forfeit the bulk of your retirement savings to the life assurance company. This annuity (fixed or variable) is guaranteed for a set number of years (typically between 10 and 20); should you die within the guarantee period, your heirs will continue to receive your pension for the remainder of the guarantee period. You will continue to receive your pension if you survive the guarantee period, but then the payments will then cease upon your death (ie your heirs no longer benefit).
iv. Capital-back guaranteed annuity: This combines an annuity (fixed or variable) with a life policy. Your annuity is reduced by a premium, which pays for a life assurance policy, to the benefit of your heirs. Joint and survivorship annuity. This annuity ensures that your spouse will have an annuity (fixed or variable) after your death. You select the income level the surviving spouse will receive (typically 75%). This is recommended for couples where only the one spouse has accumulated retirement savings. This type of annuity pays out less than a single person annuity, as the longevity risk increases for the life assurance company.
v. With-profit annuity. This is an escalating pension, guaranteed for life; however, the rate of increases is not guaranteed and depends on the net (after cost) investment performance of your initial investment. Increases are declared as bonuses; and once declared, become permanent (ie part of your guaranteed pension). Pension increases are subject to smoothing, ie the life assurance company holds back some of the profit made in high-return years, to soften the blow of low-return years.
vi. Enhanced annuities. In exceptional circumstances, you may qualify for an enhanced annuity if you can demonstrate that your life expectancy is below average due to your ill-health or poor life-style choices.
2. Living annuity The Living Annuity (LA) is, in essence, an investment product. It transfers the risk and responsibility of securing an adequate income for life onto your shoulders. In return, you have greater flexibility, more control over your financial affairs, and your heirs inherit whatever is left of your capital after your death (ie your capital does not die with you).
In selecting a LA rather than a GA, you decide how to invest your savings. You can switch within the basket of investments offered by your product provider. Every year you must draw a pension from your investment. This so-called draw-down must be at least 2.5% but no more than 17.5% of the annual value of the residual capital at the policy anniversary date. Your draw-down rate can change from year-to-year. Unless you have the necessary investment expertise, you should consult a reputable retirement planning tool or financial advisor on the appropriate draw-down rate and asset allocation.
Your heirs inherit any residual capital after your death; they can choose to receive a lump sum, an ongoing annuity or an accelerated annuity (paying out over five years). LAs are offered by banks, collective investment schemes (such as unit trust management companies), life assurance companies and registered pension funds, but are classified as life assurance policies. You are entitled to switch between product providers at any stage, but you should do so only for sound reasons, such as an increase in costs, poor service or inappropriate investment choices.
LAs are mainly sold through Lisps (linked-investment service providers). Lisps are essentially administrators who invest your money according to your instructions. They then track the performance of your investments. Lisps do not provide financial advice and you normally have to deal with them through a registered financial adviser. A LA is riskier than a guaranteed life annuity. A guaranteed life annuity will provide you with monthly income for the rest of your life. You have no such certainty with an LA as you assume the longevity risk (the risk that you last longer than your savings).
Costs are an important consideration with any investment, also for a living annuity. These products are potentially very expensive. Most LAs charge initial fees, annual fees, transaction charges and investment management fees. The 10X LA only charges one annual investment management fee.
