PERSONAL FINANCE TIPS
Choose wisely at retirement to ensure your money outlasts you – here are your choices
Here’s some of what you need to bear in mind when choosing an annuity when you retire.
Once you reach retirement, you need to make investment choices to ensure that the money you have saved will last as long as you live.
You have three choices in this regard: a living annuity, a guaranteed life annuity or a hybrid annuity, which is a combination of the first two.
How the different annuities work
Living annuity: This allows you to draw down an amount each month, anywhere between 2.5% and 17.5% of your capital annually, and you can change your draw-down rate every year.
Guaranteed annuity or life annuity: You agree to a fixed monthly amount and can stipulate the period over which this will be paid out – 20, 30 or even 35 years.
Hybrid annuity: Income from the life annuity component gives you sufficient peace of mind and liquidity to fund your essential expenses for day-to-day living, while the remaining living annuity assets can be invested to provide long-term capital growth.
Two recent cases from the Office of the Ombud for Financial Services Providers (FAIS Ombud) highlight the importance of understanding your choices and seeking the proper advice.
Complaint 1’s lesson: You can’t change the frequency of your payout once selected
In the first case, the complainant was 63 years old. In February 2017, he bought a life or guaranteed annuity with a monthly payout. In August 2021, he changed fund managers, and the value of his annuity policy was R1.4-million.
Owing to unforeseen circumstances, he wanted to access some of the funds from his annuity to settle an outstanding amount of R150,000 on his home loan and avoid losing the home. Following advice from an independent financial adviser, he tried to change the payment frequency from monthly to annually, as this would have released the money he required. The fund manager denied this request.
The complainant argued that the financial adviser initially overseeing the policy had not fully explained all the options and had failed to recommend alternatives that aligned better with his financial needs.
Complaint 2’s lesson: Once you have bought a compulsory annuity, you cannot access the money as a lump sum later on
A nurse’s employer switched pension fund administrators, granting her access to her retirement benefits at 55. She resigned and chose to take one-third of her retirement benefits as a lump sum and invested the remaining R207,000 in a guaranteed annuity, ensuring her a monthly income for life.
The nurse then started doing contractual work with NGOs, but found that her monthly income was insufficient to cover her living expenses. At this point, she tried to access the R207,000 she had used to buy the guaranteed annuity, but was unable to do so.
“In both cases, our office couldn’t aid the complainants, as they had already been informed about their annuity options and how they function,” says the FAIS Ombud.
“The common issue was a misunderstanding of the flexibility and limitations of their chosen annuity plans…”
Capital legacy versus income legacy
Many pensioners are put off by the fact that once the guaranteed life annuity has been bought, the capital sum is converted to income, and this cannot be reversed. The implication is that when you die, no lump sum benefit can be paid to your beneficiaries.
However, consulting actuary Jeanine Astrup says you have the option to leave an income legacy with a guaranteed life annuity by adding a dependant who will continue receiving an income once you die, for a guaranteed period or for life.
“It is important to understand that these options come at a cost and will reduce the income you receive during your lifetime,” Astrup adds. Having crunched the numbers, she is firm that most retirees would be better off buying guaranteed life annuities or a hybrid solution.
“This is especially true in the current environment, where guaranteed life annuity rates are at levels last seen more than 10 years ago.
This represents an incredible opportunity if you are retiring.”
For example, a man retiring at 65 with R1-million saved up decides to buy a guaranteed life annuity with a 10-year guarantee because he would like to leave something for his daughter should he die before he turns 75.
He wants his pension to keep pace with inflation and opts for a guaranteed life annuity that increases with inflation every year.
Read more in Daily Maverick: With a bit of creativity, you can pay less tax on retirement income
Astrup’s calculations show his starting pension before tax is R7,117. By the time he turns 85, his monthly pre-tax income will have increased with expected inflation of 6% to R22,824 and will continue to increase until he dies, even if he lives to 100 or more.
A living annuity investment, on the other hand, would have wiped out a significant portion of the R1-million invested over the 20 years if he had opted for a starting pre-tax income of R7,117 a month, requiring a draw-down rate of 8.54%.
Assuming that the living annuity pension increases with inflation each year until it reaches the living annuity draw-down cap of 17.5%, this pensioner would be left with a monthly income of just R7,006 by the time he turns 85.
The calculations assumed a very optimistic investment growth of inflation plus 6.5% and 1% upfront commission and 1% continuing fees (inclusive of VAT). DM
This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R29.