My mother has recently retired. She has been a teacher for the last 36 years and her biggest cause of anxiety just before retirement was how she would get used to her ‘endless leave’. But more than that, I wondered how far her retirement benefits would last her.
About 5 years before her statutory retirement date, she started actively paying off all her debts. She had literally survived all her active work life servicing loans which is the norm for most civil servants. As much as she hadn’t figured out how she will spend her time after retirement, she was clear that her retirement benefits would not be touched to clear any loan.
After getting out of debt she increased her Sacco share contributions which she planned to redeem once she retires and cease contributions all the same to the Sacco. Retirement, also meant that her TSC-sponsored medical cover was coming to an end.
Here are some options we are exploring to protect her from the uncertainties of the future but with priority to her biggest concerns, i.e. income protection, and her medical coverage.
Income Protection
With her TSC-sponsored provident fund pension scheme, she has 2 options, either to get her lump sum pension savings or get a portion of the lump sum and receive a periodical payout of about ¾ of her last monthly pay from her former employer.
Here are some options that can guarantee her income throughout her ‘endless leave’.
- Income Drawdown
An income drawdown is a method of accessing retirement funds in a flexible and customizable manner. It will allow her to withdraw a regular income from her pension savings while the balance remains invested and able to grow.
With an income drawdown, she has the freedom to choose how much income to withdraw each year/month and it can vary depending on her circumstances, providing her with control over her retirement finances. She also gets to enjoy tax-free withdrawals as long as she withdraws not more than KES 25,000 per month equivalent to KES 300,000 per year.
Features of income drawdown
- Flexibility: Income drawdown provides flexibility in managing retirement funds. You get to choose how and when to draw down your income. You can decide to take a regular income, make irregular withdrawals, or even take a lump sum if required. The amount withdrawn may be subject to certain limits and may have tax implications. In Kenya, you enjoy tax benefits with redemptions of not more than KES 25,000 per month.
- Investment Control: With income drawdown you can typically choose how their pension funds are invested, allowing them to potentially benefit from investment growth and take advantage of different investment options. However, it’s important to note that investments can also go down in value, and there is a risk of capital erosion.
- Sustainability: One challenge of income drawdown is managing the longevity of retirement funds. Withdrawals need to be balanced to ensure that the funds last throughout retirement. The minimum number of years to hold an income drawdown contract is 10 years meaning your pension benefits and withdrawals, should last you not less than 10 years. Hypothetically, if your pension principal amount is KES 1,000,000 and you opt for an income drawdown, if all things are held constant and not taking into account the return on investment, you should be getting about KES 8,000 per month.
It is, therefore, necessary to carefully assess your lifestyle expenses, investment performance, and life expectancy is crucial to maintain a sustainable income over the long term. - Regulatory Limits: Income drawdown is subject to certain regulatory limits set by the government. These limits determine the maximum amount that can be withdrawn each year and are based on factors such as age and pension value. These limits are reviewed periodically, and it’s essential to stay updated with any changes. Currently, in Kenya, you cannot withdraw more than 15% of your principal amount on a yearly basis.
- Annuity
An annuity is a financial product offered by insurance companies that will provide her with a regular income stream in exchange for her lump sum payment or a series of premium payments, this case being the lump sum amount. The annuity will provide her with a guaranteed income during retirement years or for a specified period with a minimum of 10 years.
The annuity will be giving her a fixed and regular income for the rest of her life, but unlike the income drawdown, she will not have ‘control’ over her retirement benefits.
Features of an annuity
- Guaranteed Income: Annuities are designed to provide a guaranteed income stream. Depending on the type of annuity, the income payments can be for a fixed period with a minimum of 10 years, or for the rest of her life.
To note, once you have committed to an annuity, you can’t cash it in or surrender it and you can’t make any changes once it’s up and running. - Lump Sum or Periodic Premiums: Annuities can be funded through a lump sum payment or through periodic premium payments made over time.
- Payout Options: Annuities typically offer various payout options to suit individual preferences and needs. These options can include a life annuity (for the rest of her life), period certain annuity (payments for a specified period), joint and survivor annuity (payments for the lifetimes of the annuitant and their spouse/partner), and more.
- Death Benefit Options: Some annuities may include death benefit options. These options allow for the remaining value of the annuity to be paid out to designated beneficiaries upon the annuitant’s death, providing a financial legacy.
- Insurance Protection: Annuities are often provided by insurance companies, therefore offering a sense of security since they are backed by the insurer’s financial strength and stability.
- Bond Ladder
In case she decides to withdraw the whole amount she has in her provident fund, she can create a bond ladder for herself. A bond ladder or bond layering is when you purchase a variety of bonds that all have differing mature dates and staggered coupon payment dates, leading to a steady stream of income. Bond laddering is low risk and will allow her to avoid the impact of increased tax rates especially when invested in the Government Infrastructure Bonds (IFB) which are tax-free. She will know what she is getting and when as interest (coupons) until the bonds mature.
Here is an example of a bond ladder:
| PORTFOLIO | COUPON (Interest Rate) | BOND AMOUNT |
| Bond 1 | 14.500% | 2,000,000.00 |
| Bond 2 | 13.900% | 1,500,000.00 |
| Bond 3 | 13.700% | 1,500,000.00 |
| PRINCIPAL | 5,000,000.00 |
| COUPON PAYMENT MONTH | COUPON AMOUNT | BOND |
| MARCH | 145,000 | Bond 1 |
| MAY | 104,250 | Bond 2 |
| JUNE | 102,750 | Bond 3 |
| SEPT | 145,000 | Bond 1 |
| NOV | 104,250 | Bond 2 |
| DEC | 102,750 | Bond 3 |
| YEARLY INCOME | 704,000 |
Features of Bond Layering
- Minimal risk: Government Bonds are generally considered risk-free and holding the bonds until maturity means she won’t face any capital losses. In the end, she has been receiving the coupon and she will eventually redeem her principal amount at maturity.
- Predictable income: When done properly, bond laddering can result in predictable monthly, quarterly, and yearly income.
- High trading costs: She might end up facing high initial costs when purchasing the bonds in the secondary market to enable proper layering however this cost can be eventually recovered from the coupon payments.
- Reinvesting earnings: She can decide to reinvest her bond earnings, therefore increasing her portfolio and literally taking advantage of the compounding effect.
