COVID: Financial implications of an early retirement

The current pandemic has undoubtedly resulted in people increasingly doing introspection. Whether it be health wise, financially, and even career wise. For many people who’re closer to retirement, the consideration of taking an early retirement especially if they have co-morbidities may be tempting.

In this part of our Covid-19 content series we chat to industry experts to understand the financial implications of an early retirement, especially as a result of the pandemic.

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It goes without saying that nearly all South Africans have been put under immense financial pressure by the Covid-19 pandemic, as well as the temporary lockdown measures which government has put in place to limit the spread of this highly contagious and potentially deadly virus.

“The nation-wide lockdown at the end of March 2020 – although necessary – left many small businesses and individuals exposed, without any way to earn an income. The subsequent risk-adjusted strategy means that economic activity in certain sectors will remain limited. This will result in reduced earnings for many individuals and businesses,” says Kobus Liebenberg, marketing actuary for Metropolitan Life.

Following this, Liebenberg adds that as a result many South Africans didn’t consider their retirement nest egg over the past few months, as they were struggling to make ends meet.

“This is understandable. However, retirement savings are one of the most important investments anyone could make over their lifetime, and it should be viewed as a long-term commitment. While it may appear as a viable solution to alleviate financial pressure in the short term, there are many risks involved,” he adds.

The decision to retire early, before the age of 65, is becoming more popular and can be split into two broad categories, explains Richard Bray, head of strategy and positioning for Amplify Investment Partners:

1. Discretionary retirement:

Individuals who have considered an early retirement based on their own discretion. These people probably have enough retirement savings in place and are concerned about contracting the virus due to pre-existing health issues or old age.

They may also be wanting to add new purpose to their lives by pursuing lifelong dreams or goals such as a new business venture or local travel. Whilst some of these individuals might not have enough to retire, they’re willing to change their lifestyles accordingly as they follow a life that is more relevant for them such as spending more time with family or communities in need.

2. Forced retirement:

These individuals have been forced to take early retirement due concerns of catching the virus or concerns about their future earnings as a result of the pandemic. Older adults and people who have severe underlying medical conditions are at higher risk for developing more serious complications from the corona virus and may consider early retirement as a solution to protect their health.

Uncertainty around recovery and growth of future earnings may see many business owners feeling that the risk is not worth the effort and they may consider selling or closing their businesses. The same can be said of employees opting for retrenchment packages as they fear the future viabilities of their employer.

How are finances affected?

“The Johannesburg Stock Exchange (JSE) sunk to levels last seen at the end of 2012, completely overshadowing the impact of the 2008 financial crisis. The extent to which individuals’ retirement savings were affected depends on the investment portfolio underlying their savings. While some asset class values reduced (shares, for example) others remained relatively stable.

“Those invested in smooth bonus portfolios, which are normally less volatile than the underlying assets themselves, were also affected. Insurers had to put in place interim market value adjustments which could apply when an individual chooses to retire earlier, depending on the normal retirement age reflected in their membership certificate. This was in response to the economic downturn to protect the funding levels of these portfolios, so that different generations of members invested in the portfolio are treated fairly,” adds Liebenberg.

He continued saying that choosing to retire earlier than expected, especially over the next few months, could mean that a policy holder’s retirement savings would be valued at a much lower rate than before the pandemic hit. Chances are that these reduced savings will not be able to purchase a retirement income which will sustain their standard of living.

Their retirement savings will also need to last for an even longer period of time as a result of the earlier retirement, thereby reducing the potential income level further, Liebenberg explains.

Can an early retirement be a good move?

“Unless the person is financially comfortable or has health or family issues and needs to retire, total early retirement is generally not a good move. People are living longer than ever before and generally are not retiring with sufficient savings (in SA only around 6% retire comfortably). Generally there has also been talk of increasing the retirement age in order to take into account the fact people are living longer,” adds investment company Franc.

There also could be the option to reduce working hours or trying to find alternative (less stressful/less time consuming) employment if that is available so that the person can still generate an income to mitigate the factors above, Franc adds.

Simply put, Franc says a healthy retirement savings balance and a plan as to how it’s going to last you, are crucial.

Moore adds that a pensioner’s approach to retirement should always be the same, regardless of the market conditions, where retirement savings should be looked at as two pots. He explains:

“The first pot should ensure you have enough sustainable income to cover your essential expenses for life. The second pot is for discretionary spending or to leave as a legacy. The way to secure the first pot with certainty is with a life annuity or by switching a portion of your assets in your living annuity to a lifetime income portfolio in your living annuity. Once your first pot is secured, you can consider options that provide flexibility, growth, and a legacy for beneficiaries,” Moore says.

Adding to the list of things to consider before making the move Liebenberg says:

• Cut back on luxuries and non-essential expenses or put these on hold until your financial situation improves. Examples of luxury or non-essential spending include buying a new car, renovating your house, an overseas holiday, and shopping at expensive stores.
  
  
• Consider alternative ways to generate an income in the meantime. Examples include making protective masks for your local community or turning a hobby into a career – like baking and cooking.
  
  
• Consider withdrawals from other savings, which might not have penalty charges for early access e.g. savings in their bank accounts or tax-free savings plans. It could, however, mean that you will be jeopardising the goals for which these savings were initially intended.

The bottom line

The bottom line is that early retirement should only be considered as a last resort, and only exercised when an individual has no other options. The decisions which people make at retirement – for example, which portion of their savings to take in cash and which annuity to purchase – need careful consideration and financial planning. The majority of at-retirement choices are irreversible and can have long-term consequences if these were uninformed or ill-considered, Liebenberg says.

Added to this, South Africans are notoriously poor savers. This is because we don’t start saving early enough, don’t dedicate enough of our income towards savings, or make unnecessary and untimely withdrawals from our savings when we change jobs. All of these factors play a part in South Africans missing out on the power of compound interest and having their savings grow to sufficient levels.

To access other parts in our Covid-19 Content series, click here.