WORDS ON WEALTH
A huge proportion of South Africans buy a living annuity to fund their retirement. A small number opt for a life, or guaranteed, annuity, provided by a life insurance company. With the first type, you, the retiree, assume the investment risk; with the second, the insurer assumes the risk, guaranteeing you an income for life.
Retirees are risk averse - and rightly so. After all, you shouldn’t be taking unnecessary risks with your life savings. It baffles me why more people don’t opt for life annuities.
I’m not against living annuities per se; well managed, they are suitable for many retirees. But how many are well managed?
A worrying point is that living annuities are often bought by people who haven’t saved enough for retirement and who aim to squeeze from them more than they could get from a life annuity. This could backfire badly, as they would probably be selecting both higher-risk investments and a higher-than-sustainable drawdown rate.
Did you know that the income from a
life annuity, which eliminates the risks of market crashes and of you outliving your money, can be higher than the recommended drawdown from a living annuity? It certainly is at present.
Each quarter, for Personal Finance magazine, I receive life annuity rates from several large life insurance companies. For the first quarter, the rates were valid for January 1. On that date, for R1 million, a married couple aged 65 could buy an income of between R4 300 and R4 900 a month, depending on the provider, escalating at 6% a year to keep pace with inflation, until the death of the last-surviving spouse. Furthermore, if both died within 10 years of inception, their beneficiaries would receive the income for the remainder of the 10-year guarantee period.
An income of R4 900 a month from R1m equates to an annual drawdown of 5.8%. This is after costs, which are included in the rates. A widely recommended safe initial drawdown on a living annuity is 4%. This would give you R3 333 a month before costs, which could chew up another 2%. You would need to clear 6% to exceed the income from a life annuity. Add 2% costs, and you’re looking at a highly unsustainable 8% annual drawdown.
On receiving the annuity rates for the second-quarter magazine, I discovered, to my surprise, that they were, on average, 20% higher than January’s. A life annuity with the same conditions as above, bought on April 1, would have provided an income of between R5 300 and R5 800 a month, representing a drawdown of between 7% and 7.6%.
These rates change almost daily. (On the day you buy the annuity, you are locked into that rate for life.) They are linked to government bond yields, which normally correlate with interest rates. But with the market crash at the end of March, plus our credit downgrade by Moody’s, the yield on 10-year government bonds spiked, going from about 8.5% to 12.3% within days, contrary to interest rates, which have fallen.
The yields have subsided since then, to about 10%, so the annuity rates will also have dropped. But they are very attractive for someone who will then never have to worry about where the next penny’s coming from.
When you retire, you need to be perfectly clear about all your options, on which your adviser should be objective. Advisers tend to earn higher commissions on living annuities than on the life products. If you get the slightest inkling that the adviser is putting his or her own interests above yours, walk away and get another opinion. (You should probably get another opinion anyway. This
is the rest of your life we’re talking about,
after all.)