Your retirement needs

In essence your retirement needs can be split as:

• Your basic needs
• Your luxury needs

Basic needs

This is the minimum income that you and your dependants would require in your retirement to retain your basic quality of life.

Your basic needs typically include the money you need for:

• Accommodation;
• Food for you and your family;
• Clothes;
• Medical expenses; and
• Transport.

Pensioners have different expectations from life - some pensioners may feel that an income of R800 per month is enough to cover their basic needs; others may feel that they need an income of R8 000 a month to meet these needs.

The reality is that many people end-up retiring without enough money to meet even their basic needs in retirement.

Consider the following question carefully:

• What monthly income you require to meet your basic needs in retirement?
• What percentage is this of your current salary?

Luxury needs

Very few people earn enough money, either whilst they are working or in retirement, to be able to meet their luxury needs. Such an income allows you access to most of the things you desire in life.

Key risks you face

Having defined your needs, one needs to consider what key risks you face in meeting those needs and how one can manage these risks. In managing your risks you should be most concerned about minimizing the chance of outcomes that cause you a great deal of regret and difficulty.

As a pensioner, there are three important risks you must deal with in how you invest your retirement savings in order to meet your needs, namely:

• Investment risk
• Inflation risk
• Somewhat surprisingly, the risk of living too long!

Investment risk

Investment risk refers to the chance that the investment return you earn on the money you invest at your retirement is insufficient to provide a reasonable income throughout your retirement.

As a former member of a defined contribution arrangement, you should be aware of and have experienced investment risk. As you know investment risk depends largely on the asset class (e.g. shares, bonds or cash) in which you invest your money and your investment horizon.

Inflation risk

One of the big risks you face in retirement is that inflation reduces the buying power of your pension.

It is very difficult to predict the future course of inflation (i.e. it may go much lower or maybe it could increase sharply). It is therefore important that you invest your retirement money, or at least that part which covers your basic needs, in such a way that your income goes up each year more or less in line with inflation.

The following chart shows how the buying power of how R100 declines over each of the next 20 years if average future inflation is, 5% p.a., 10% p.a., 15% p.a. and 20% p.a.

Clearly future inflation is a significant risk to your standard of living in retirement.

Risk of living too long

This seems like an unusual risk - but the longer you and your dependants live, the more money you need whilst you are on pension. Many people have a pessimistic view of how much longer they will live once they retire. The following table shows, how long, on average a male and female are expected to live if they retire at different ages.

Retirement age	Life expectancy
		Male	Female
55	22 years	27 years
60	18 years	22 years
65	14 years	18 years

The above figures may well understate the position, because as medical research improves (and it is improving at a dramatic rate currently), the life expectancy of people may increase.

Key features of a pension

Now that you have an understanding of:

• What monthly income you need to cover your basic and luxury needs
• The important risks you face in retirement

the next step is to understand the key features of a pension. Any pension has the five key features, namely:

• Choice
• The degree of investment expertise you must have to manage your pension
• Security
• Inheritability
• Cost structure

These five features are described below - consider them carefully because next you will be asked to vote for which feature you value most highly. 

Choice

Choice means the feature that you can choose each year the amount of income you receive and also how your money is invested. Such choice means that you have the flexibility to change your pension according to your needs every year.

A vote for this feature would indicate that you attach a lot of value to choice.

The degree of investment expertise you must have to manage your pension

The investment expertise you must have to manage your pension. Some pensions require you to have a great deal of expertise in investing and managing your money.

A vote for this feature indicates that you rate your investment competence highly and will therefore attach a great deal of value to this feature.

Security

Security means the extent to which your annual pension is certain to be paid.

A vote for this feature says that it is important for you to have "peace of mind" with respect to your pension.

Inheritability

Inheritability means the extent to which your dependants will benefit from your pension when you die. A narrow form of inheritability is when only the people that are financially dependent on you (e.g. your spouse) continue receiving a pension when you die.

A broader form of inheritability is when even people that are financially independent (e.g. your adult children) continue receiving a pension after you and your spouse have died.

A high vote for this feature indicates that you attach a high value to the broader form of inheritability.

Costs associated with the pension

Different forms of pension have higher associated cost structures. Higher costs are not necessarily bad, but you need to receive adequate value for these higher costs.

A vote for this feature indicates that you want to keep the costs associated with your pension as low as possible.

You are given four "votes" to allocate to the above features. You are allowed to weight your vote - for example, if you feel that the inheritability is the only feature that is important, you could cast all four votes for inheritability.

Feature	Number of votes you cast for this feature
Choice
Your required investment expertise
Security
Inheritability
Low cost structure

In this section we consider the main types of pensions offered by the insurance market and the Cape Municipal Pension Fund for defined contribution section members. We explain what the key features of these pensions are. Of course, the final step is to match this with your preferred features of a pension.

The two main types of pension offered by the market are a:

• Life annuity (This is also the default annuity strategy chosen by your Trustees which represents the best choice for the average member)
• A living annuity

We highlight that the market offers many variations of these two annuities - this section focuses on the core elements of such annuities.

Life annuity

A life annuity typically has the following features:

• The current amount of the pension is guaranteed for the rest of your life. (This guarantee depends on the party providing your pension and meeting its obligation even in extreme market conditions.)

   

• On your death typically 50% to 75% of your pension will be paid to your surviving spouse for the rest of her/his life. (You can elect the percentage pension that will be paid to your spouse on your death.) 

  A concern sometimes raised about a life annuity is that you don't get the full value of your retirement capital if you and your spouse die soon after you retire. This is the "insurance premium" you pay for having the promise that your pension will be paid even if you live much longer than expected (e.g. to age 100).

• The pension should increase each year. (However, in poor market conditions no pension increase may be granted.) Once an increase is granted, the new higher level of pension becomes guaranteed. (You can elect the basis on which the annual increase should take place).

   

• You require no investment expertise in managing such a pension. The CMPF or the Insurer providing the pension will manage the underlying assets on your behalf.

   

• The pension has a low cost structure.

   

• With a life annuity you can decide at the outset on the basis on which your pension should increase each year and the percentage pension paid to your spouse on your death. However, you do not have the flexibility to change these terms once your pension starts to be paid.

   

In order to check your understanding of the features of a life annuity, please complete the following table by giving each of the key features a rating of 0 to 4. A rating of 4 indicates that this feature is strongly represented; a rating of 0 means that the life annuity does not contain this feature.

Feature	Your Rating
Choice
You must have a high degree of investment expertise
Security
Inheritability
Low cost structure

The Fund's rating of the features in set out in the table below. You can check your understanding of a life annuity by comparing your rating to the Fund's.

The rating is somewhat subjective so you should not be concerned if your rating is 1 point higher or lower than the Fund's. On the other hand if your rating for a feature is much higher or lower than the Fund's then you should revisit your understanding of a life annuity.

Feature of a life annuity	Fund's rating	Reason for rating
Choice	1	Only have choice at the start of the pension
You must have a high degree of investment expertise	0	CMPF or Insurer makes the investment decisions
Security	4	The current pension is guaranteed, subject to very small counter-party risk (but future increases are not)
Inheritability	2	Your surviving spouse continues to receive a pension on your death
Low cost structure	4	This is cheap pension structure

Living annuity

A living annuity operates like an Investment Account as is explained below.

• At retirement your money is invested in your Investment Account.

   

• Your Investment Account is credited with the investment returns (positive or negative) you earn on your money.

   

• Importantly, you must decide how to invest your Investment Account. Of course, you may chose to receive expert advice in this regard.

• Each year you need to decide on the level of your draw down. The draw-down limit is set by the South African Revenue Services and is as follows:

Minimum draw down: 2.5% of the balance in your Investment Account

Maximum draw down: The lesser of   

-          17.5% of the balance in your Investment Account

      Or

The amount of a guaranteed non-profit single life annuity (with no guarantee and no increases) that can be secured   with  the living annuity capital.

• When you die, your dependants take over your Account. Those relatives that are financially dependent on you take over the account first. When they die, the balance in your Investment Account can be paid to your financially independent children. In this way your retirement capital can have value beyond your death and that of your spouse.

   

• Your Investment Account can run out of money and you may be left with a very low income in retirement. This can typically happen if:
  1. The investment return you earn on your Investment Account is low.
  2. The monthly drawings you make from your Investment Account are too high.
  3. You (and your spouse) live much longer than expected.

   

• The cost structure of a living annuity is typically higher than that of a life annuity as the investment fees are higher and you need to pay for the on-going advice you receive from an adviser regarding your investment strategy and monthly drawings.

   

• You can apply your Investment Account to secure a life annuity before age 75. The later you do this, the more expensive the life annuity becomes.

In effect a living annuity works in the same way as your Member Credit, but in reverse - instead of making contributions (paying into your Account), you are taking money out of your Account.

As above, in order to check your understanding of the features of a living annuity, please complete the following table by giving each of the features a rating of 0 to 4.

Feature of a living annuity	Your Rating
Choice
You must have a high degree of investment expertise
Security
Inheritability
Low cost structure

Our rating of the features in set out in the table below. Again you can check your understanding of a living annuity by comparing your rating to ours.

Feature of a living annuity	Fund's rating	Reason for rating
Choice	3	You have the flexibility to vary to your income and investment strategy each year
You must have a high degree of investment expertise	3	You will need to decide where your money is invested, although you may take advice in this regard
Security	1	There is a risk of running out of money investment returns are poor, you draw too much pension or you live too long
Inheritability	4	Your surviving spouse continues to receive a pension on your death
Low cost structure	1	This is more expensive structure

The best way of assessing which type of pension best meets your needs you should first match-up how you voted for the different features with the key features of the main types of annuity.

Secondly you should consider whether any special circumstances apply to you.

This section also provides a "quick test" as to whether a living annuity may be suitable for you.

How you voted for the features

In this section you should compare the number of votes you cast for each feature with the key features of each of a life annuity and a living annuity.

Feature of a life annuity	Your Rating	Number of votes you cast
Choice
You must have a high degree of investment expertise
Security
Inheritability
Low cost structure

 

Feature of a living annuity	Your Rating	Number of votes you cast
Choice
You must have a high degree of investment expertise
Security
Inheritability
Low cost structure

As a starting point you should choose the type of pension that contains most of the features you have voted for.

Special circumstances

• If you are in ill-health

  An important exception in your decision making process is if you know that you are in ill health at the time when you retire.

  In this case a living annuity may be a suitable pension form. Life annuities are usually priced based on a normal life expectancy - a life annuity is clearly an expensive option if you have a shorter life expectancy than normal.

  Of course the key difficulty with this is that very few members have sufficient information to take the view that their life expectancy will be shorter than normal. People often under-estimate how long they will live after retirement, particularly with improving medical techniques and research.

   

• If your "basic needs" pension is much lower than the total pension you can secure

  The Fund has a "Pension Calculator" that will help you to calculate the pension you can buy with your pension savings.

  Some people may find that their "basic needs" pension is lower than the total pension they can secure.

  It is easy to conclude that a life annuity (which targets increases each year more or less in line with inflation) is the best form of pension to meet your "basic needs" pension. On the other hand a living annuity seems best suited towards meeting your "luxury needs". (Providing inheritability for your independent children is generally a luxury.)

  In this case you may elect to use a life annuity to provide your "basic needs" and living annuity to cover your "luxury needs" (i.e. a combination of the two annuities).

   

• If you were to emigrate

  If you were to emigrate on retirement, a living annuity represents a mechanism for taking your pension out of South Africa relatively quickly.

  Given that you are now living offshore you ideally need to receive a pension based in the currency of your new home as opposed to Rand.

  With a living annuity you can draw 20% of your Investment Account balance each year. In this way you can accelerate the transfer of your pension offshore.

Quick guideline

If in order to meet your basic needs pension you would need to draw more than 7% of the capital you invest in a living annuity, you should seriously reconsider whether a living annuity is appropriate for you. (This rule does not apply if you know you are in ill health at your retirement.)

As the Cape Municipal Pension Fund is a Pension Fund you may take up to a maximum of 1/3rd of your retirement benefit in cash. The amount that you should take in cash depends on your individual circumstances (you should take advice in this regard), but the following guidelines may be useful:

• It may be sensible to take a cash benefit to pay off any long term debts you have. Debt is expensive and a good investment is to pay it off.
• Depending on your tax position if may be sensible to take the maximum tax-free cash benefit you receive. You should invest this amount to give you an income in retirement, but in a more tax efficient manner than receiving a pension.
• You may find that your retirement capital is of such a level that even if you apply your entire benefit to secure a pension, you will not pay any tax.
• You need to be sure that you invest any amount you elect to receive in cash prudently. Ideally you should avoid complex investments that you cannot understand. The reality is that you probably will need to live off your retirement capital for the next 20 years.

NOTE: With effect from 1 March 2016, the de minimis amount will increase from R75 000 to R247 500. This means that ONLY if your full fund value exceeds R247 500 will you be required to annuitise a minimum of 2/3rd of your fund value. If your value is R247 500 or less, you may receive the full amount as a lump sum on retirement.

The monthly pension you receive will depend on:

• How much of your retirement benefit you decide to use for a pension benefit (you must apply at least 2/3rds of your retirement benefit towards a pension)

• In the case of a life annuity the provision you make for future pension increases and for a pension to be paid to your spouse on your death 

• In the case of a living annuity your pension will depend mainly on investment returns and how much you draw monthly as a pension

Life annuity

The toolbox contains a "Life Annuity" calculator. You can use this calculator to get a feel of how the provision for future pension increases and percentage to be paid to your spouse impacts on your monthly pension.

A common practice of financial advisor's is to quote you a pension that makes no provision for future pension increases. Such a pension will be about 60% to 70% higher than the pension you could receive if you made provision for future pension increases more or less in line with inflation.

The danger of electing a pension that makes no provision for future increases is that you expose yourself (and your spouse) to the risk of inflation.

Living annuity

The toolbox contains a "Living Annuity" calculator. You can use this calculator to model the impact of different investment strategies and monthly pension drawings on how long your retirement capital could last.

The most important decision you need to make is whether to receive your pension as a life annuity or as a living annuity. The previous sections have tried to assist you in making this decision.

The final step in the process is to decide whether to receive your pension from the Cape Municipal Pension Fund or from a financial services organisation. The Fund only provides detailed information about the pension options it provides. If you require advice on the pension options outside the Fund you should contact a financial adviser.

The CMPF offers you the option of a life annuity or a living annuity. 

The life annuity is the default annuity strategy. This means that, on an opt-in basis, Trustees consider the life annuity to be the best option for the average member.

It is important to emphasise that:

• The Fund offers fairly simple pension options, as it believes that such options will meet the needs of the majority of members.
• You still have the option of securing your pension outside the CMPF. If you elect this option you will leave the Fund with your retirement money and you and your dependants will have no further claim against the CMPF.