New products, new reality

2014-10-12 15:00

Maya Fisher-French looks at how to leave a legacy while guaranteeing your income in retirement

People generally have two fears when it comes to ­retirement: whether they will have sufficient income during retirement, and what will happen to their ­retirement money if they die during early retirement.

In the case of a life annuity, the income stops when they die (unless they had a joint annuity with their spouse) and their children receive no inheritance from the parent’s life savings.

For this reason, living annuities have become popular products. A living annuity invests the lump sum in a market-related investment and the retiree might draw down anywhere from 2.5% to 17% of the capital each year.

The investment has the opportunity to grow at above inflation as it is market-linked. Should the retiree die leaving capital, this amount can be paid to their beneficiaries.

Unfortunately, because so few people retire with sufficient capital, they are forced to draw down more than the recommended 5% to 6% a year and many retirees outlive their capital.

In comparison, a traditional life annuity pays a guaranteed monthly income for the rest of your life and can be linked to inflation so you are guaranteed to continue to receive an income – but it cannot be left to your children.

Nearly 80% of retirees are now opting for living annuities. Although this might be a desire to leave a legacy, the reality is that most retirees have not saved enough to purchase a ­sufficient guaranteed income and need to draw down ­aggressively on their capital in retirement, leaving them destitute in later years.

This has become so pervasive, the Treasury has raised concerns about the mis-selling of the product, resulting in the retirement industry returning to the drawing board to find new solutions that blend the positive aspects of a guaranteed income with those of market-linked investments. We should continue to see more innovation around retirement products over the next few years.

Hybrid annuities

Glacier by Sanlam Investment-linked Lifetime Income Plan

This product is for an investor who wants to know their money will not run out, and also wants the benefit of a potentially higher income in retirement.

The product blends the benefits of an income for life with the ­potential for above-inflation income by linking the annual income ­increases to underlying market returns. If there has been a strong market performance, a retiree could see their annual income increase ahead of inflation – but like any investment, with any upside comes the risk of downside.

If the underlying investment delivers a flat or negative return, a ­retiree could see their income dip as costs still need to be deducted, irrespective of returns. But if, over time, the market delivers above­inflation returns, the retiree would have a significant increase in their income over time. The risk would be for a market correction in the first or second year of the investment.

Like a traditional life annuity, the income dies with the retiree or the spouse and would not provide for leaving an inheritance – but, given the current retirement statistics from the 2013 Old ­Mutual Retirement Survey, which found that 45% of retirees expect to run out of money in retirement, leaving a legacy is not necessarily an option for most retirees.

Liberty Flexible Annuity

This is for someone who wants to have some form of guaranteed ­income and leave a legacy. The Liberty Flexible Annuity aims to provide retirees with some protection against outliving their capital, while also providing them with an option to leave some form of inheritance. When investing in an investment-linked living annuity, a retiree can commit a percentage of their retirement savings to the “income ­enhancer benefit”. The commitment by retirees who have died forms a bonus pool that can pay out annual bonuses. This bonus can be used to supplement the retiree’s income or be added to the retirement investment for growth. When the retiree dies, the balance that ­remains in the investment-linked annuity that was not committed to the “income enhancer benefit” is paid to their beneficiaries.

Old Mutual Living Annuity with Investment Top-up

This is for someone who wants the flexibility of a living annuity, and also some protection against longevity.

The Investment Top-up can be taken out in conjunction with a living annuity and provides a lump sum on survival to a certain age. You would use a portion of your living annuity investment (maximum of 8%) to purchase a single premium guarantee to pay out a lump sum should you reach a certain age. The minimum age you can select is 75 and

the oldest is 95. This allows for better financial planning as you can select a lump sum to kick in, for example, at the age of 80. You would then be able to structure your living annuity to provide an income until that age. If you die before the age you selected, no benefit is paid out.

Old Mutual also offers a life annuity with a death benefit (capital preservation), which pays out a lump sum on your death so you are still able to leave your children an inheritance while guaranteeing your income. As this product does not require underwriting, it might be less expensive to take your own life cover if you are in good health.

Alexander Forbes Lifestage Annuity

This uses financial planning to combine a living annuity with a life annuity. According to Alexander Forbes, it is worthwhile considering the merits of a hybrid annuity, which in essence allows you to initially invest in a living annuity, then convert to a life annuity several years after retirement. By initially investing in a living annuity, you are able to allow your money to grow (as long as you do not draw down too much) and the annuity rates, or “implied yield”, you receive from a life annuity increase the later you invest.

The later you annuitise, the higher the yield (or income as a percentage of your lump sum investment) as you are funding fewer years in retirement. So by delaying the purchase of a guaranteed annuity, you are able to increase the amount you receive monthly.

Interest rates also affect the level of annuity you would receive. If interest rates are low – as has been the case recently – you would be locked ­into a low-interest annuity and miss out on future interest rate ­increases.

In a low-interest rate environment, it makes sense to delay the purchase of an annuity until the interest rates are higher.

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