Why you should have two pots for retirement

 ·12 Apr 2020

Retirement in the time of Covid-19 sees pensioners facing the risk of not having a sustainable income due to the current environment that has seen investment market crashes, reducing retirement savings substantially.

Should market conditions persist for the next 12 months, retirement income specialist Just believes that pensioners may run out of money years earlier than in normal investment conditions.

Chief executive, Deane Moore looks at some sensible steps that pensioners can take to protect their income in the current climate.

Since the beginning of January, the JSE All Share Index is down by more than 25% and according Just, living annuity pensioners who maintain their income in rand terms are now drawing roughly 1% more from their assets and consuming capital that won’t be there when markets recover.

“If current market conditions persist for 12 months and markets then recover to pre-crash levels, pensioners are likely to run out of money four years earlier than under normal investment conditions,” said Moore.

Market noise is currently focused on the polar opposites of “panic and sell-out” or “do nothing and wait”. However, the decision on how to assess and mitigate risk in retirement is the same today as in any market conditions, and the actions required are also the same.

Moore said there are some sensible steps pensioners can take to protect their retirement income.

Think about retirement savings in two pots

The first pot should ensure you have enough sustainable income to cover your essential expenses for life; and the second pot is for discretionary spending or to leave as a legacy.

“To determine how much you need in your first pot, calculate how much you spend on monthly essentials: food, accommodation, utilities, medical, transport and insurances.

“Your income needs to cover these monthly essentials, no matter how long you live or what happens to investment markets. It is not a good idea to take any risk with the funds in this pot,” said Moore.

The second pot of assets is where you can take some risk. Because this pot is used to fund discretionary expenses, you can afford to cut back on discretionary spending when markets fall or accept that the legacy will not be as big as it would have been in different market conditions, he said.

Secure your income for life

For those who believe markets will recover, there are options that combine a guaranteed income for life with increases that are linked to a balanced portfolio. These are available as lifetime income portfolios in some living annuities, or as with-profit life annuities, said Moore.

Those who do not believe investment markets will recover significantly in their lifetime, might wish to consider a full switch to a life annuity.

“This would require potentially crystalising investment losses. Inflation-linked annuities increase each year with CPI. Fixed escalation annuities increase by a fixed amount each year – this may be cold comfort if inflation increases to a higher amount in future years,” said Moore.

Read: What happens to your retirement savings if your company shuts its doors?

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