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Wednesday, May 14, 2014

Planning for a sustainable retirement

The Business Times
Lorna Tan

BUYING an annuity insurance policy is a daunting experience.

That was how I felt when I forked out $100,000 to insurance cooperative NTUC Income in 2011 in return for some peace of mind in my golden years.

It was unnerving not only because I coughed up a six-figure sum as a one-time single premium. It was daunting because, knowing that I'm here on earth on borrowed time, I felt as if I was audaciously negotiating with my maker for a longer life.

After all, it makes sense to buy an annuity only if I believe that I can live (God willing), and am committed to living, a long healthy life.

In 2011, I bought NTUC Income's Guaranteed Life Annuity policy, which is expected to pay a regular guaranteed income - $700 per month or $8,685 per year - from the time I turn 65 till I die.
So the longer I live, the more payouts I get to enjoy from the insurance policy.

But what happens if my "longevity" plan fails?

The policy comes with a death benefit that will be paid to my beneficiaries in one lump sum.
There are two scenarios. If death were to occur before I turn 65, the higher of the single premium or 97 per cent of the premium accumulated with interest and bonuses, is paid.

If death were to occur after the annuity payouts have started, the premium with interest and bonuses accumulated from the time I purchased the policy till my death, less the total annuity payments made, would be refunded.

The interest rate is guaranteed at 2.5 per cent per annum. And what if I change my mind and wish to surrender the policy? I could do so but it is not advisable as buying a life insurance policy, particularly an annuity, is a long-term commitment and an early termination involves high costs.

I would incur a loss if the surrender value is less than the premium paid. I can only "win" from buying the Guaranteed Life Annuity plan if I live a long life.

At least, until I live past 90, which is when I "break even". On a 2.5 per cent interest rate, it takes roughly 25 years for me to recoup, through the annuity payouts, my original $100,000 single premium, which would have compounded to $160,000 by the time I reach my drawdown age of 65.
Some of you may wonder why I bought an annuity.

After all, this would be on top of another annuity plan, the compulsory national annuity scheme called CPF LIFE (Lifelong Income For the Elderly), which Singaporeans or permanent residents born in 1958 or after would be placed on, when they reach 55. Under this scheme, members receive a monthly income for life, starting from their drawdown age.

If you are now a 50-year old male and have the CPF Minimum Sum of $148,000, your default CPF LIFE monthly payout from age 65 would be from $1,157 to $1,283. (The CPF Minimum Sum will be raised to $155,000 from July.)

Women are expected to live longer lives (87 for females, 83 for men) so the payouts based on the current Minimum Sum are lower, projected to be $1,053 to $1,172.

Well, the decision came about after I did an about-turn in my retirement planning.

Like many people in the past, I used to think that retirement planning is all about accumulating a certain magic number - depending on your desired lifestyle - before the drawdown phase kicks in. Not anymore.

As life expectancies increase, thanks to a host of reasons such as advanced medical science, one retirement risk we potentially face is the danger of outliving our nest egg.

It has been reported that for Singaporeans who are 65 today, about half of them are expected to live another 20 years (that is, 85 and beyond), while a third will live beyond 90. Therefore the difficulty of determining this magic retirement sum increases as well, rendering such an approach unsustainable. How much of this lump sum is enough? What if we get our sums wrong?

I used to think I would have achieved financial independence and could call it a day at work when I reach my retirement target of a million dollars.

I was wrong. Faced with a longer life expectancy, the rising cost of living, ongoing support for my ageing parents and an estimated overseas education bill of about $500,000 to be chalked up by my two kids in the coming years, I had to redo my sums.

To mitigate this risk, I've shifted my focus to ensuring lifelong cash flows or income sources - which we can call an income goal - that would fund my golden years, instead of just achieving a certain magic number.

Having an income (better still, if it is inflation-protected) throughout my golden years is now a measure of my success in retirement planning.

This income goal has a few important characteristics:
•The cash flows should be regular and sustainable.
•They should generate enough income for me to live on at all times, whether the economy is up or down.

A good way to get started is to work out the cash flows you need, followed by the crucial step of matching the investments that will generate income sources to fund the desired cash flows.
To make it easy to work out my cash flow needs, I pictured a money pyramid, much like a food pyramid, with the basic subsistence category of needs at the bottom.

Here, I would include essentials, such as food, housing, medical, insurance, utilities, and allowance to parents. It is prudent to project realistically how much you would need (say, $3,500) to sustain these retirement essentials. And I would want to ensure that the income flows required to fund these needs are safe, predictable and guaranteed.

Begin by listing the regular, sustainable and guaranteed recurring income flows (say, $1,500) that you already have and work out the cash flow gap ($2,000), before deciding how this gap could be closed.
This is where the two annuities I own would come in handy as they would potentially provide two streams of "guaranteed" income flows totalling about $1,700 per month.

Other financial instruments that would qualify are bank savings, monies and investments parked in my Supplementary Retirement Scheme account, dividend payments from real estate investment trusts (Reits), coupon payouts from bonds and preferred stocks, and rental income from investment properties.

The next layer in the money pyramid is the category of wants or non-essential items that I could do without if I couldn't afford them, such as cable TV, dining out, shopping, gifts, leisure activities and vacations. The income flows channelled to satisfy these wants would be generated by investments that offer growth and capital appreciation, and may be volatile. Examples are stocks, unit trusts, commodities and hedge funds.

In summary, they would be relatively less safe, less predictable and less guaranteed compared with the investments you match with the cash flows of your essential needs.

The rationale is that as I have taken care of my essentials, I can take more risk with the remainder of my retirement savings. Of course, this would also depend on your risk appetite and capacity. It is easy to fall into the mistake of matching the wrong investments with the different categories of cash flows. For instance, I wouldn't expect my investments in single stocks to fund my essential needs.

Here's why:

Taking a pointer from the financial meltdown in 2008 when stock prices headed south, many retirees who primarily invested in stocks found themselves caught in a situation where they either got out of the stock market with huge losses or gritted their teeth and tried to stay invested for better days.

When their stock investments were unable to immediately generate the cash flows they needed, they faced the dire choices of either going back to work and/or cutting down their expenses drastically.

In a best-case scenario, if I could successfully achieve my income goal, I could live off that income during my lifetime and bequeath my principal savings and assets to my beneficiaries.

Now, that would be planning my retirement sustainably.

The writer is the author of 'More Talk Money' and 'Talk Money', and former Sunday Times Invest editor. She is senior vice-president, corporate communications, at CapitaLand

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