Retirement Seminar Presentation

Olivia van der Hoven Dave Strugnell

UCTRF Principal Officer AU-nominated trustee

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Broad agenda for today: What choices will I have to make at retirement? What does that mean for choices I make between now and then? What options are available to me to improve my chances of a financially successful retirement? Hopefully, lots of space for questions

Disclosure

Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. This is an information session designed to empower you to make more informed decisions; if you are in need of financial advice, this should be sought from a licensed professional.

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Your UCTRF Retirement Savings Account

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(1) Choices at retirement

Why are we talking about this? I have years until retirement!

Perhaps the most financially significant decision you will take in your life is how you convert your retirement savings into an income to last through your retirement years. It’s important enough that you should engage with it well

in advance of retirement, especially because what you plan to do at retirement might (indeed should) influence what you do before retirement.

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Benefits available at Retirement UCTRF = the value of your Retirement Savings Account

•0 – 100% available in cash (partially taxable) •Decide upfront the cash amount you require •Remainder – apply for pension (tax-free transfer) •Pension instalments – taxable at PAYE

From UCT: Leave pay Any benefits due from deferred compensation policies Post-Retirement Medical Aid Subsidy

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Other options to consider at Retirement Separate Group Life Assurance Policy (Death Cover) Conversion option on 1xDPA separate death cover policy Can be converted to an individual policy in own name without proof of health (1x

pensionable & any optional cover chosen) May be utilised to cover estate duty Capital injection in case of pensioner's death

Other Policies Your other policies: Preservation funds, Retirement Annuities, Deferred Compensation

policies, Endowment policies, investments UIF, Medical Aid 8

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Cash or no cash? Tax formula: Lump sum Percentage First R500,000 0% Next R200,000 taxed at 18% Next R350,000 taxed at 27% Balance > R1,050,000 taxed at 36%

Note: Investment return on pension capital is not taxable

• It is not subject to CGT • If paid to dependants, does not form part of estate so no estate

duty payable

Note: Settle o/s debt, unless you are sure potential returns on investment is higher than the interest you pay on debt Remember: what you take in cash, you sacrifice in income.

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How do I decide on the best option for me?

The two most important questions you will probably face are: •How should I invest (or what should I do with) my retirement money?

•What amount of income can I expect to get monthly from this investment?

Following the "6 step process" could be useful in helping you answer these rather complex questions.

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6 Step Process Model

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Establishing your retirement needs

Basic needs Luxury needs Accommodation Things you desire

Food Holidays

Clothing

Transport

Medical Expenses

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Retirement Expenses

You need to think about your expenses once you retire. It is very likely that you will need less money after you retire because:

Your house may be paid for in full by the time you retire Your children may no longer be financially dependent on you You may have to pay less tax - once you are over age 65; the amount of tax

you pay reduces Your travelling costs may reduce, as you will not need to go to work each day

On the other hand some of your expenses may go up. In particular, your medical expenses usually increase when you get older

Experts typically recommend aiming for retirement income of 70% to 80% of your total salary just before retirement. If your accumulated retirement savings don’t provide for this much, you’re in good company, but some adjustment to your lifestyle or some alternative source of income in retirement may be necessary. 14

Risks you face in retirement Investment Risk:

Investment return earned insufficient to provide reasonable income Inflation Risk: Inflation reduces buying power of pension Risk of living too long:

Outliving your capital, if longevity risk has not been transferred to an insurer

Your primary choice: life annuity or living annuity?

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0.25.50.75.

100.125.

0 2 4 6 8 10 12 14 16 18 20

With improvements in medical technology, life expectancy continues to increase. Bear in mind that these life expectancies imply a 50:50 chance that you will live longer!

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Current age Male life expectancy Female life expectancy 60 80 85 65 82 86 70 84 87

Life Annuity

Current level of pension guaranteed Each year a pension increase is granted (you can choose the form

and level of the increase) Pension payable for your life You can provide that the pension be paid to your spouse on your

death You have no involvement in the management of the assets after you

have selected your pension provider

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Life Annuity: Spouse’s Pension You can elect the percentage of your pension paid to your spouse or

partner on your death (single life pensions, without continuation to a spouse, are also available) Most common choices are 50% or 75% of your pension

By choosing a higher percentage, you improve inheritability of your

pension at the "price" of a lower initial pension

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Life Annuity: Minimum Pension You can elect that your pension be paid for a minimum period of say

5 ,10 or 15 years, even if you and your spouse or partner were to die in this period Also called "term certain" or guaranteed period - in this case

pension paid to persons that are financially independent of you Guaranteed period improves inheritability of pension - "price" is

reduction in initial pension Common practice is to have a guaranteed period of 5 years

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Life Annuity : Different scenarios

Age 60 Age 80 Life expectancy Male

Scenario 1: You die at 64, with no spouse and no guarantee period:

Pension to you Balance stays with Insurer

Age 60 Age 80 Age 64

The pension is guaranteed for your life and costed accordingly:

Scenario 2: You die at 94, with no spouse and no guarantee period:

Age 60 Age 80

Pension to you Your money runs out BUT Insurer continues paying pension

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Life Annuity: Different scenarios

Scenario 4: You die at 64, with a 70% spouse’s pension, but no guarantee period:

Pension to you

Age 60 Age 80 Age 64

Scenario 5: You die at 64, with a 70% spouse’s pension, and 10-yr guarantee period:

Age 60 Age 64 Age 80

Pension to you Your full pension is paid to your spouse

Pension reduces to 70% and is paid to spouse for her life

Age 70

Pension to spouse reduces to 70% for her life

Scenario 3: You die at 64, your wife dies at 66, but with a 10-yr guarantee period:

64 66 Age 80 Age 60

Pension to you & continues to your spouse

Pension to dependants

Age 70

Balance stays with Insurer

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Different types of Life Annuity

Level pension Guaranteed escalation pension

With-profits pension

Inflation-guaranteed pension

Fundamental difference is how they provide for future pension increases!

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Level or guaranteed escalation pension Stipulated escalation (e.g. 0%, 3%, 5%)

Exposed to risk of inflation increasing

Future pension increases equal to inflation Lowest initial pension (appear expensive, but this is

because you’re paying the price of protecting your real income)

Inflation Guaranteed Pension

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With-Profits Pension Pension secured budgeting for investment return of say 5% p.a.

Difference between actual investment return and 5% p.a. is the

increase Depends on investment returns in excess of 5% p.a. for future

increases Reasonable match against inflation risk

Main disadvantage: if investment returns are poor, may receive

no pension increase 24

Life Annuity: Comparisons

4 000

8 000

12 000

16 000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Inflation LinkedWith profit - average3% increaseLevel

Approximate Rand value of monthly pension

Years after retirement

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How a living annuity works

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Important distinction: living annuity is an investment product, life annuity is an insurance product.

Living annuity options

Living Annuity from a LISP

Or Living Annuity from the Fund

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Key features of a living annuity You decide how money is invested (should take advice)

You decide your drawdown rate (payments may be monthly,

quarterly, half-yearly or annually in arrears)

Minimum: 2.5% of your opening balance

Maximum: lesser of • 17.5% of the balance in Investment Account Or • Amount of a fixed non-profit single life annuity (with no minimum payment term

and no increases) that can be secured with living annuity capital

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Key features of a living annuity

Can change your investment strategy/drawdown annually Spouse stands in your place if you die, then dependent

children and finally independent children (inheritability) You take on mortality risk: you could run out of money (poor

investment returns, too large a drawdown, live too long) Higher cost structure (pay for advice, more complex

administration) Can secure Life Annuity before age 75

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In search of a sustainable retirement income

Source: Lodhia & Swanepoel 2012: Living versus Guaranteed annuities: In search of a sustainable retirement income

Life annuities are better equipped than living annuities to provide an inflation-linked income for life, because of the benefit of mortality pooling.

Inflation-linked income through living annuity

Unless your drawdown rate is less than the real (after-inflation) investment return on your assets, keeping pace with inflation will require an increasing drawdown rate

This has a finite lifespan before the cap of 17.5% is reached

How long this takes depends on your investment returns and

your initial drawdown rate, but once it is reached, expect real income to halve every 3-4 years Suppose you reach the cap by age 75: by 78-79, your real

income will have halved, will be 25% of its original value by about age 82 and about 12% by age 85 31

Annuity Overview: Pros & Cons

Pros: • Peace of mind: transfer of the risk of living longer

than expected • Protection of the real value of your income (if

escalations are chosen, esp. inflation-linked)

Cons: • Loss of control over your investments and lock-in • Limited ability to pass on an inheritance (but is this

the point of retirement savings?) • Longevity risk transfer comes at a price

Life annuity:

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Annuity Overview: Pros & Cons

Pros: • Flexibility to meet your needs in retirement • Investment choice • Some control over inheritance • Useful as a temporary measure, or in ill health

Cons: • Serious risk of outliving your retirement capital! • Need for financial advice on investment strategy

and income drawdown, and ongoing decisions • High commissions, advice and management fees

Living annuity:

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Understanding living annuity costs Initial Costs:

• take on fee of LISP • initial commission of adviser

Annual Costs:

• administration cost of LISP • ongoing advice fee of adviser • Transaction Cost – Switch of investment portfolio cost

Investment Manager Cost:

• annual management fee • performance fees

Living annuities from LISPs are generally more costly than from UCTRF..

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Living Annuity – comparison of costs UCTRF : Administration Initial R400 per member account Ongoing R28.38 per member per month EXAMPLE: R500 000 ACCOUNT: Administration R400 initial, then R340.56 per annum

Retail : (This is based on the best case-scenario) Administration – Initial 1% (can vary anywhere between 1% - 1.7%) Ongoing 0.75% of first R250,000 0.50% of next R500,000 0.25% of next R250,000 EXAMPLE: R500 000 ACCOUNT: Initial: R5,000 Ongoing: R3,125 per annum

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Which product is best for me?

You will need reflection, and perhaps impartial advice, to make that decision.

Factors in the decision:

•Cost of Life Annuities •Inflation •Life expectancy •Spending patterns •Financial needs after you have died •Volatile investment markets •Other income options in retirement

Viable strategy for those retiring with other sources of income: take living annuity and draw down the minimum, aiming to convert to a life annuity at a later stage.

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You have sufficient capital at retirement and you want flexibility

You want to benefit from the mortality benefits offered by risk pooling

You have access to skilled, trusted and independent financial advice

You require a known guaranteed annuity with no investment risk during retirement

You want to leave a financial inheritance when you die

You don’t want to run the risk of out living your income for the rest of your life

You would like to be involved in decision making during retirement

You have a life expectancy < 15 years

Consider a Living Annuity if

Consider a Life Annuity if

You are not married and / or you don’t have a very strong bequest motive

You have a life expectancy > 15 years

It depends on how much you’ve saved. A life annuity isn’t a solution for saving too little, though it does protect you against running out of money.

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(2) So how do I plan and prepare for retirement?

Questions to ask Am I on target? how much do I have? how much do I need? how much do I need to save, and how should I invest it?

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How much do you have? Your Annual Benefit Statement Try the UCTRF website link to the Sanlam Retirement Fund

Web •Register in a few easy steps •Check your balance whenever you need to

Try the Retirement Calculator in the toolbox on the UCTRF website for projected Retirement Benefits based on your chosen options

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How much do you need?

A much more difficult question to answer! For most members, the Retirement Fund Benefit is the

largest asset they will ever own, and sound management of Retirement Fund assets is crucial because members of a defined contribution fund carry the risks of investment. Sources of guidance include the retirement calculator and

financial advice.

Speak to a Financial Advisor Financial advisor checklist:

• Ask for referees/clients • Necessary FSB & FAIS registration? • Preferably CFP-qualified (or with equivalent professional

credentials) • Independent or affiliated? • Relationships/networks with other players in the financial

services sector? • Ensure costs and commissions disclosed in full • Be aware of vested interests; you want impartial advice!

HR & UCTRF – provide information not advice

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Have you saved enough? How can I enhance my expected retirement benefit?

• Increase your DPA • Additional contributions • Consider your investment choice • Reduce your risk cover (provided your dependants remain

adequately covered) • If you were considering early retirement, reorient your goals

towards retiring at age 65

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Distribution of DPA in the UCTRF

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How to change your DPA You may increase (or decrease) your DPA at an annual CoE review

Change will result in:

1) a greater (or lesser) UCTRF contribution amount.

2) associated increase (or decrease) in the Group Life Assurance cover,

disability cover and the fringe benefit on the Separate Group Life

Assurance cover.

(Staff who wish to decrease their DPA to less than the recommended amount must schedule an interview with their HR Advisor who will take them through the consequences of their decision and ask them to sign an acknowledgment of these consequences.)

If any changes in DPA or additional contributions result in your retirement contribution being greater than 20% of your earnings for the current tax year, UCT is legally obliged to advise SARS (South African Revenue Service).

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UCTRF Additional contributions You can request UCT to make additional contributions to your UCTRF retirement savings (HR152 form): 0% pa (default) 1, 2 or 3% as additional retirement savings 2.67% (+2 months' pensionable service per annum); or 5.33% (+ 4 months' pensionable service per annum) These funds are before tax: they go directly into retirement savings; they make no contribution to admin. costs or risk benefits; they will reduce your take home pay (but maybe by less than you fear,

given the tax saving) changes to the tax regime from 1 March 2015 will limit the potential for

additional contributions for high earners (total cap on contributions of R350,000 p.a.) 48

Investment Strategy When saving for retirement, it is important to earn as high a return as

possible subject to a manageable level of risk. Therefore, your money in the fund has to be invested in the portfolio that best suits your needs

Available investment channels:

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What is the Life Stage Model?

When is the Life Stage model not necessarily appropriate: When you intend to retire earlier than the normal retirement age When you do not intend to take any cash at retirement and intend to

purchase a living annuity (in which you would typically retain some exposure to the market)

Members with 5 years or more to retirement, will initially have all their Funds invested in the Balanced Fund. As returns from the Balanced Fund are expected to fluctuate from year to year, it is not an ideal portfolio for managing final payment risk. Members are therefore transitioned to the Income Fund as they near retirement.

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Why not retire early? Thanks to the magic of compound interest, the greatest

gains (in Rand terms) on your accumulated savings will occur between the ages of 60 and 65; so you’ll have more cash if you delay retirement. And because life expectancy reduces with every additional

year, every Rand of accumulated retirement benefits will purchase you more retirement income at 65 than at earlier ages; so your income conversion rate is improved. The combined effect means a healthier post-retirement

income if you delay retirement to 65.

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Case study 40 year-old male senior lecturer, CoE = R595,903 p.a. Married with two children Discovery Coastal Saver medical scheme option Red parking bay DPA = 80% of CoE Accumulated retirement savings = R1 million Invested in Portfolio A (the Income Fund)

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Assumptions Real returns (in excess of inflation): Portfolio A: 0.5% Portfolio B: 2% Portfolio C: 4% Portfolio D: 3%

Salary increases: 7% p.a. (1% above inflation of 6%) Net contribution to retirement savings: 20.15% of DPA,

plus any additional voluntary contributions CPI-linked annuity at 65, allowing for 50% continuation to

spouse, = 5.5% p.a. of capital value

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Net salary retirement savings: R96,060 p.a. net salary: R26,099 p.m.

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Projected retirement benefits projected fund credit at 65: R16.689 million sounds impressive, but a big chunk of this is just

inflation… in real terms, R3.889 million gross annuity: R17,822 p.m. (29% of projected gross CoE)

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What could be done to improve this? review investment strategy: the income fund is too

conservative for such a long investment horizon review the DPA consider additional contributions

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Review investment strategy the Balanced Fund (Portfolio C) is probably most

appropriate for a 25-year investment horizon as the horizon shortens closer to retirement, it may be

too risky, however so let’s consider the lifestage approach as an alternative

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Projected retirement benefits (no change to net salary, of course) projected fund credit: R6.140 million in real terms (a 58%

improvement over the Income Fund, although it must be stressed that more variability in the outcome is introduced) annuity: R28,143 p.m. (45% of projected CoE)

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Increase DPA to 100% retirement savings increase to R120,074 p.a. but net salary reduces to R24,634 p.m. (R1,465 less) projected fund credit: R7.102 million in real terms annuity: R32,552 p.m. (52.3% of projected CoE)

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Further 5.33% additional contribution retirement savings increase to R151,836 p.a. net salary reduces to R22,914 p.m. (a further reduction of

R1,720) projected real fund credit: R8.375 million annuity: R38,384 p.m. (61.7% of projected CoE) accepting the pain of a lower salary today can make a

significant difference to the likelihood of a relatively comfortable retirement later

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So what next? use the tools available to you to play around with options and see

the effects on take-home pay and projected benefits CoE calculator: http://www.uctweb.co.za/HRUct/ retirement calculator: http://uctrf.co.za/23/L/Retirement-

Provision-Calculator your current values: https://www.retirementfundweb.co.za/ much more information at www.uctrf.co.za talk to the Principal Officer’s office or HR for more info consider seeking financial advice (www.fpi.co.za is a good place to

start), but never suspend your own critical judgement!

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Questions? Thank You

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