The lowdown on annuities in retirement

2014-09-14 15:00

If you’re about to retire,?chances are you will?use?your retirement savings to?buy a pension. Neesa? Moodley-Isaacs discusses?the two options available?to?you – a guaranteed life?annuity and an?investment-linked living?annuity.?

First, the decision of whether to choose a guaranteed life annuity or an investment-linked living?annuity (ILLA) is entirely an individual choice and will depend on a number of factors including your age at retirement, your health, whether you want to leave a pension to your dependants and the standard of living you hope to enjoy.

You might want to bear in mind the fact that more than 23% of working South Africans fall into the “sandwich generation”.

This means in addition to providing for their own families, they are also financially responsible for their parents. When you are making decisions about your retirement money, remember that the best gift you can give your children is that of being financially independent of them.

A scary statistic to bear in mind when saving for retirement, then planning your post-retirement financial choices, is that for every year you expect to live in retirement, you need to accumulate about 10% to 15% more capital.

If you retired tomorrow, you would be able to withdraw the full amount saved in a provident fund but only a third of that saved in a pension fund – the remaining two-thirds have to be used to provide an income in retirement.

Retirement reforms in the pipeline mean that eventually you will not be able to withdraw 100% of your retirement savings in a provident fund but will have to use the majority of your savings to buy a pension.

This is not an initiative to steal your money. Rather, it is there to ensure you will have an income in your retirement instead of blowing it all when you withdraw it at retirement. (See “Reforms”)

Guaranteed life annuity

A guaranteed life annuity will pay you a monthly income for as long as you live, explains Nico-Louis Minnie, the head of wealth platforms at Liberty Investments. An additional benefit is that if you want to ensure your dependants are taken care of after you die, you can structure your guaranteed life annuity to continue payments to your beneficiaries for a fixed period after you die. The maximum term is determined by your investment company.

For example, Liberty offers competitive annuity rates with a maximum guaranteed term of 10 years worth of payments to your beneficiaries after you die.

One of the associated “drawbacks” of a guaranteed life annuity is that it is usually set at a lower amount than the pension you would be able to draw from an ILLA. The major benefit is that the risk is borne by the investment company and you are guaranteed an income for as long as you live.

An investment-linked living annuity

This is an investment from which you are able to draw down a variable pension each year. As Minnie puts it: “A living annuity works like a bank account so you simply draw money out of it on a monthly basis to provide you with income.”

Annually, you are allowed to decide what percentage of your investment you want to draw down on a monthly basis. The drawdown rate ranges from 2.5% to 17.5% each year.

The major disadvantage is if you draw down too much, you run the risk of depleting your funds before you die. On the other hand, if you are prudent about your drawdown rate, you can leave a financial legacy for your beneficiaries.

Any funds remaining in your ILLA when you die will go to your nominated beneficiaries. A conservative drawdown rate that should also allow you to maintain a reasonable standard of living is 6% a year, although this is dependent on individual circumstances.

Leaving a financial legacy

If you do want to leave a financial legacy for your dependants or beneficiaries, there are options other than sacrificing your retirement income. You could take out a life insurance policy that is specifically intended for this purpose and still remain financially independent in your old age.

This ensures you are not a financial burden on your children while you are alive and you leave them a financial legacy.

But put some careful thought into this option before you act on it. According to Liberty, R1?million life insurance on a 70-year-old female nonsmoker would cost in the region of R1?640.

Assuming premium increases of 8.5% per annum, you would have paid about R300?000 in premiums by the time you turn 80.

That is a significant amount that could go towards your retirement needs instead. Or you could ask your beneficiaries to maintain premium payments on your behalf.

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