Securing a retirement income: A primer on your options

MARKET uncertainty and volatility have only whetted the appetite for a steady, passve income. When it comes to retirement income planning, the good news is that there is a wealth of options.

The caveats are that you will need to be discerning on the risks you take and the product costs as well. Any product with built-in guarantees such as insurance will be more costly.

Be wary too of the proliferation of social media advertising via avenues like Facebook which tout high yields, and high retirement income "for life''.

While the ads don't appear to be scams - the ones this writer has seen suggest unit trusts or insurance products - prominent displays of high historical returns are misleading and possibly even inaccurate.

In any case, the year-to-date market downdraft has already caused double-digit losses in some equity funds.

By any measure, income investing is challenging, and this is especially so for pre-retirees and those already in retirement. Assets traditionally seen as lower risk such as bonds suffered losses in 2021 and the year to date.

In addition to the prospect of higher interest rates, an environment of higher inflation is also challenging for bonds.

Apart from market risk, retirees grapple with a set of other risks, including: One, a low tolerance for loss, which arises as retirees cease to earn a regular income from work and begin to draw down on their assets for living expenses.

Two, they may live longer than they have planned for and may outlive their savings.

Three, medical expenses in later years are likely to be higher than ever. While most Singaporeans do have hospitalisation cover through MediShield Life and a private Shield plan, Shield premiums in advanced ages are in the thousands of dollars a year.

The maximum withdrawal limit for those age 70 and above is set at S$900. An IP plan for restructured hospitals may cost over S$4,000 a year for those in their 80s.

Four, the challenge of a withdrawal rate. How much can retirees withdraw a month from their portfolio to ensure their assets will outlast them?

A recent Morningstar study finds that the standard so-called rule of thumb of 4 per cent withdrawal rate based on a US study should be adjusted downwards to 3.3 per cent - "...assuming a balanced portfolio, fixed real withdrawals over a 30-year time horizon, and a 90 per cent probability of success (that is, a high likelihood of not running out of funds over the time horizon)".

These risks explain why savers here favour CPF Life which pays an income for life, and insurance products which have some built-in guarantees. Insurance products, however, are not without risk.

Here are some options for retirement income:

CPF Life

This is an annuity scheme offered by the CPF, and serves as an assured base for retirement income planning. It is the most cost-efficient and attractive annuity around.

Your capital is secure, and the savings in the Retirement Account continue to earn interest of up to 6 per cent.

Your goal should be to set aside up to the maximum of the Enhanced Retirement Sum, which currently stands at S$288,000 for a 55-year-old. This is expected to generate a payout of S$2,100 to S$2,300 a month from age 65.

This is the current estimate for those who turn 65 in 2032. You can maximise the income by delaying the start of income payout to 70.

Note that the income isn't guaranteed. CPF says payouts may be adjusted to take into account long-term changes in interest rates and life expectancy. "Such adjustments (if any) are expected to be small and gradual,'' it says.

Insurance

There are broadly 2 options: participating (par) plans where the insurer invests on your behalf and returns are smoothed; and investment-linked plans (ILP) where you decide on the asset allocation and pick the underlying fund or funds.

The attraction of par plans for savers is that the income may be guaranteed; you can specify the amount you desire, and the age at which the monthly payout should begin. Premiums may be paid as a lump sum or over a specified term.

The Life Insurance Association defines an annuity as a plan that pays an income "for the rest of your life''.

Most insurers do not describe their plans as annuities, because the eventual payouts are for a specific term. You can, however, find plans that pay to age 100 or even 120.

The broad outlines of the plans, which are generally endowments, are similar. Your illustration will show the porions of income that are guaranteed and not guaranteed.

The projections will be based on two hypothetical return rates of 3 and 4.25 per cent, and the effective yield or internal rate of return (IRR) for either scenario is disclosed. This IRR is indicative of the insurer's expense ratio.

For income planning, what you should be prepared for is the lower possible outcome based on 3 per cent projection, and the likelihood that if the investment experience is poor, the non-guaranteed portion may be reduced and your total income payout may be less than you expected.

Meanwhile a comparison of lump sum premiums for a guaranteed monthly income of S$2,000 highlights why CPF Life is a good deal. The quotes are for male, age 55, with payouts for 20 years starting from age 65.

Here are just two examples: One insurer quotes a lump sum premium of S$480,000 for a male age 55, for a guaranteed S$2,000 monthly income to be paid for 20 years. Another quotes a lump sum premium of S$396,455.

CPF Life will require S$248,000 in the retirement account for a male age 55, to pay S$2,000 income for life from 65.

Turning to investment-linked plans (ILPs), I have examined these at various points of my writing career and have invariably been pretty appalled at the high built-in costs. It appears that not much has changed.

The underlying fund/s chosen by the policyholder will levy the normal annual management fee, reflected in the fund price.

But there is a host of other charges because of the insurance wrapper, such as an annual "supplementary'' charge, admin charge, mortality or insurance cost plus distribution cost.

The upshot is that it really isn't easy to work out the effective expense ratio.

But a typical illustration will show that there is hardly any surrender value in the first few years, and the breakeven point between the surrender value and total premiums paid is long - typically more than 10 years. This is indicative of high costs.

In any case, the expenses are charged via cancellation of units. That is, you may end the year with fewer units that you started with, making it even harder to track your return.

Another danger is that at the lower assumed rate of return of 4 per cent, your fixed income withdrawal may only last a few years. At older ages, the policy value also dwindles because of regular withdrawals and insurance costs.

Portfolio of equities, multi-asset and fixed income funds

One of the most welcome developments in the funds market today is the emergence of robo portfolios with low costs.

For a long-term retirement portfolio, it is as important to keep costs low as it is to calibrate the risks you are willing or need to take.

Endowus, for instance, recently launched its income portfolio series targeted at three profiles of investors. While the funds aim to generate income, actual payouts in retirement are not automated. Hence you will need to address the tricky question of a sustainable withdrawal rate.

There is also a plethora of funds with distribution units; some pay out as frequently as monthly.

When you do your research, be wary of funds that promise a yield higher than what a portfolio can generate from its assets, because it means the fund is making distributions out of capital.

You will want to avoid funds that pay heavily out of capital because what you are receiving as yield is actually the return of your own capital.