Good news! Across the world, people are living longer. The bad news? Most aren’t saving for their retirement – and those who are may not be doing so effectively.

Good homes have solid foundations

Before you retire, you need to consider what your income needs are going to be when you stop working, what retirement capital you’ll have accumulated, and what the payout options will be.

When it comes to the payout options, you can use your retirement capital to purchase one of two main products to provide you with a monthly income – a life or a living annuity.

A life annuity provides an income until you (or you and your partner) die, giving you a constant, predetermined payment for as long as you live. Life annuities are also sometimes called conventional or guaranteed annuities, because your income (after retirement) is guaranteed for life, and there’s no risk of receiving less if markets perform badly.

A living annuity, on the other hand, is a retirement income option that lets you decide how much income you earn. Your capital is linked to the investment market’s performance (so it could increase or decrease), and you decide once a year how much of your investment you need to draw.

Andrew Davison, Head of Advice at Old Mutual Corporate Consultants, describes living annuities as being like a competition between a pensioner and their money. ‘The challenge lies in determining what kind of annuity will be best in providing you with an income for the rest of your life,’ he says.

‘The problem is nobody knows how long the rest of your life will be. In a guaranteed [or life] annuity, you’ll be paid out regardless of whether you live to 75 or 105. With a living annuity, however, you have to take this pot of money and make it last for an unknown number of years. And whichever runs out first – your money or your life – is the winner!’

Horses for courses

So which is better, then: a living annuity or a life annuity? Davison says that it depends on your profile and personal circumstances. ‘Everyone is different, so it’s very difficult to create a one-size-fits-all solution,’ he explains. ‘That’s precisely why Old Mutual offers tailor-made options.’

When you sit down with your financial adviser to draw up your retirement plan, you’ll need to consider your health, family history and your likelihood of living a long life. ‘If, based on your own health, and that of your parents and grandparents, you have a longer life expectancy, you should think about taking out a life annuity,’ Davison says. ‘In that competition between you and your money, and which one will outlast the other, you’ll have the odds stacked against you.’

The opposite also applies, however. If you are in poor health, and your parents and grandparents didn’t live into their 80s or 90s, you should consider a living annuity.

But what if one side of your family has a proud history of longevity, and the other doesn’t? What if you think you’re just as likely to die in your early 70s as you are to go skydiving in your late 80s?

‘Then, a combination of a life annuity and a living annuity is the most sensible option, because you get the best of both worlds,’ Davison says. ‘In this case, you’ve got the security of the guaranteed annuity, which is like insurance against living too long, and you’ve got the flexibility of the living annuity and the fact that you can leave the money to your beneficiaries.’

Most people either choose one or the other, Davison says, even though, for most people, the smartest option is a combination of the two. That’s why it’s so important to get advice from your financial adviser – they will help you make the right decision for your needs.

Compound your interest, not your problems

During your career, you might be tempted to withdraw money from your retirement savings. From a retirement planning point of view, this is almost always a bad idea as it destroys the value of your long-term savings by reducing the impact of compound interest.

What’s more, your retirement savings in the first 10 years of your career can form up to 50% of your pension. Most people don’t realise this and neglect to start planning for retirement as soon as they get their first jobs. Losing out on 10 years’ compound interest has a huge knock-on effect which is sadly only felt much later in life, as it could halve your retirement income.

‘It’s a big problem in South Africa,’ Davison says. ‘One reason is that people are under financial pressure, which makes the cash payout attractive; the other is that people don’t think of – or don’t worry about – retirement until it happens.’ Because of the growing impact of this culture of ‘dis-saving’ on the economy, the National Treasury implemented heavy tax penalties on early withdrawals from retirement savings.

Give yourself a (tax) break

While there are tax penalties for taking money out of your retirement savings before you retire, there are also tax breaks for putting money in. ‘Those retirement savings contributions are tax-deductible up to 27.5% (subject to a maximum deduction of R350 000), but most of us are saving 11% to 15% of our salary,’ says Davison.

‘The majority of people can contribute a lot more to their retirement than they currently are. I seldom see anybody contributing 27.5%. That’s a free tax break that you’re throwing away because you don’t see the benefits today; you only see them in the future.’

Davison stresses the importance of contributing as much as possible, while you can, to your retirement savings. ‘Remember the old story of the man who wondered why he never won the lotto? A voice came back saying: “You’ve got to meet me halfway and at least buy a ticket!” The same is true here: unless you’re putting the money in, there’s nothing for the compounding interest to work on.

‘Your contributions are actually quite small in terms of the overall picture, but they have a huge impact. You have to make them, and you have to make them early because they will generate the growth.’

It’s a simple equation: the more you put into your retirement savings, the more you’ll get out in the end. And – Davison says he can’t emphasise this enough – you have to start early. ‘It’s never too late to make a positive impact on your retirement plan,’ he says, ‘but you might reach a point where it’s too late to fully get to where you think you should be. You just have to bite the bullet and put more aside, because of the fact that you’re going to live longer... unless you plan on working longer.’

That’s also an option, of course. Just because your official retirement age is 65 (or 60, or maybe even 55 or 50), doesn’t mean you have to stop working – or stop earning.

‘You could look at a second career,’ Davison suggests. ‘I think most people should seriously consider working beyond whatever retirement age they had in mind. You’re much healthier and more capable at age 65 than your grandparents would have been because of the standard of healthcare we have today.’

Just ask those old ladies in South Korea.

This article originally appeared in Today Issue 1 2018.