You have two options when choosing a pension for when you retire one day. You either hand over your retirement fund to a product provider and let them provide a pension for you for the rest of your life, or you can choose to manage your own fund through your retirement.
Here are your two options explained:
The Life Annuity
This is a structured pension based on the amount of money you have accumulated together with your estimated life expectancy.
The product provider will offer you a pension for the rest of your life. Should you die sooner than estimated, the balance of your pension capital goes into the pool.
You can take out a guarantee on your pension for a period. The longer the period the lesser the pension. If for example, you choose 10 years, then the pension will be lower. If however you die in 8 years time, then the remaining 2 years of pension will be paid to the beneficiary you have nominated.
The Living Annuity
This pension allows you to invest in a wide choice of funds. You decide on your pension by making a choice between 2,5% and 17,5% of the value of your fund.
When you die, the investment passes onto your beneficiaries.
The big risk is drawing down a pension at a higher rate than the investment performance. If you achieve, say, a 10% return and draw down a 12% pension, then you effectively are eating into your capital which will result in your pension drying up a lot sooner.
You need to monitor your living annuity carefully, constantly assessing the returns and the percentage drawn down.
So which one should I choose?
If you are convinced that you will live longer than average, a life annuity is probably the better consideration. The guarantees on the pension need to be studied and understood before committing.
Ultimately, the life annuity provides certainty for your retirement around which you can plan more effectively. However, you essentially give the assurance company your money and compete with the statistics of life expectancy.
If you want control of your pension and are prepared to keep involved with the investment during your retirement years, then the living annuity is your better option. The pension drawn should be carefully considered along with the funds chosen. Be realistic about your expectations of returns, taking costs into account as it is the net value that matters.
Depending on your total provisions available at retirement you could consider a combination of these options.
Your choice of pension is a very important financial decision to make and you should seek advice from a professional financial planner to help you find the appropriate solution.
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Read more from Paul Roelofse at www.investforlife.co.za