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How to manage your post-retirement risk

Tuesday April 9 2019

Retirees take decades of financial sacrifice and deferred gratification in a bid to secure a better life after retirement.

Retirees take decades of financial sacrifice and deferred gratification in a bid to secure a better life after retirement. PHOTO | FILE | NATION MEDIA GROUP 

By ROBERT MUHIA

It takes many years and a lot of effort to save for retirement. Retirees take decades of financial sacrifice and deferred gratification in a bid to secure a better life after retirement. Professionals such as fund managers and actuaries also take their fair share of resources to ensure that retirement savings are not only safe, but also yield high returns throughout the years. So, what happens when a retiree finally gets the benefit?

Retirement saving is meant for securing your future after retirement. It is assumed that once you attain the retirement age, you will be able to continue with the current lifestyle when the salary is no longer there. With a good pension plan, you can live comfortably in a foreseeable future after retirement.

It is not a secret that most pensioners don’t know how to deal with the large amounts of payouts after many years of saving. What takes so many years to build often does not last long enough, and neither does it serve the intended purpose which is to provide financial security in the sunset days.

What happens when we finally get the cheque and what can we do to mitigate the risks involved in handling the retirement benefit?

INVESTMENT RISKS

Most retirees tend to venture into business with their retirement benefit. While it doesn’t sound like a bad idea, research shows that most end up losing their savings within a short time. If you have never started a business in your working life, then when you retire is not the right time to do so. If you have never bought shares in the last 20 years, it is certainly not a good idea to do so when you retire. Investment is a very risky affair and you can easily lose your savings. Your retirement benefit is not meant for investment capital. It is meant for securing you financially when you stop working, and all you need is a sustainable income.

CONSUMPTION RISK

Access to lump sum amounts of money comes with the inherent risk of unwise spending. More often than not, there is a tendency to adjust lifestyle by spending more than what we can actually afford in the long run.

This eventually leads to wastage of hard- earned cash on things that might be unnecessary.

It is not different when it comes to retirement savings. If unchecked, heavy spending especially in the early stage of retirement can ruin the entire retirement benefit. Many retirees have fallen to this trap and ended with big cars and other extravagant things, at the expense of a sustainable regular income.

INFLATION RISK

Inflation is a sustained increase in the general price level of essential goods and services over a period. It appears to slightly increase the costs in the short-term, but in the long-term the impact is relatively high. Inflation in Kenya is currently at an average rate of 4.5 percent. An average annual inflation rate of 4.5 percent reduces your purchasing power almost by half in 10 years, and by more than 20 percent in only five years. Even a modest inflation rate of below four percent would have a serious ramification on your savings over a long period.

Inflation poses a serious risk to retirement benefits and should be an ongoing concern for retirees. The cost of living will rise significantly in a slow but painful process over time and will reduce the purchasing power of your savings.

LONGEVITY RISK

We all want to live a long and healthy life, but what happens if we run out of funds long after retirement? Since 1900 the global life expectancy has doubled and is now approaching 70 years. Kenya average life expectancy is now at 66.7 years and getting better.

Various factors have increased lifespans and now you can live 20 to 30 years in retirement. In fact, in some cases you might live longer in retirement than your working years. This means that there a very good chance of living longer than your retirement savings. A good retirement plan should last for several decades after retirement.

How you manage these risks will determine how long you can sustain your pension income. There are many strategic plans that you can adopt based on your risk profile, the amount of benefit you have among many other factors.

Let us now look at how we can mitigate some of these risks.

PURCHASE OF ON ANNUITY

An annuity is a long-term investment plan offered by an insurance company and it is designed to protect you from the risk of outliving your retirement savings. In purchasing an annuity, you convert your lump sum pension payment into a stream of income during the entire sunset days. Annuity guarantees you income for as long as you live and in case of death, the balance of the guaranteed instalments is payable to spouse or next of kin.

Inability to access your savings in lump sum is a good thing as it instils discipline in savings. It protects you from spending the money you set aside specifically for retirement on things that may not be necessary.

To buy an annuity, you pay a lump sum premium to an insurance company before you retire. There are two main types of annuities in the market. You can go for immediate annuity or deferred annuity. Immediate annuity begins soon after payment of the first premium, whereas in deferred annuity, the income stream begins at a later date and as agreed with the insurer.

The amounts you will receive will depend on the amounts you pay to purchase the annuity, your age when you purchase the annuity and the benefit option you choose.

Annuity not only provides assurance against possible longevity risk, but it also eliminates the risks of wrong investments and unnecessary spending.

INCOME DRAWDOWN PLAN

Income drawdown plan gives you an opportunity to access your retirement benefit as a regular income through an investment fund from which the regular payments are drawn. It is an alternative to buying an annuity and can be offered by the existing retirement scheme or individual pension plan.

The minimum drawdown period is 10 years and the maximum drawdown is 15 percent of the outstanding balance. It provides flexibility in frequency timing and the amount of income withdrawals. This plan also allows you an opportunity to contribute to the fund and in return increase your monthly pay out in the long -term. The amounts withdrawn depend on the lump sum amounts invested and the period of the investment.

After 10 years you can review the plan and decide to continue with the plan, take the remaining balance as lump sum or purchase an annuity. In case of unfortunate demise, the beneficiaries can inherit the remaining fund.

With income drawdown, your funds are invested and every year, you get a return in terms of interest income. It is a sure way of investing your funds and beating inflation.

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This article was first published in the Business Daily.

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