From March this year all retirement funds must offer their members annuity (pension) options that conform to regulations that came into effect in September 2017. The aim of the regulations is to improve the likelihood that you, the fund member, will choose a pension that will last for the rest of your life.
These so-called default regulations affect three important areas of retirement saving: how your contributions are invested while you are accumulating savings (Regulation 37 of the Pension Funds Act), how easy it is to leave your savings invested when you change jobs (Regulation 38), and the options you have available to convert your retirement savings into a monthly pension for life when you retire (Regulation 39). Members will also benefit from retirement benefits counselling to provide information on and explain the implications of, these default options.
Retirees are faced with two choices on how to use their savings: choose a life insurance annuity and be guaranteed a life-long income, or a living annuity that allows for more control over and access to capital, and the ability to grow capital through investing in the markets. Those are the benefits.
The cons include the fact that life annuities don’t allow access to capital at any time and at death the insurance company – not beneficiaries – keeps the balance of the investor’s retirement savings (unless the option to leave a portion of income to a living spouse is exercised). With a living annuity there is a very real risk of running out of money before the investor dies.
A newish hybrid annuity product provides a flexible set of options to optimise balance between self-insuring and being insured for retirement, to counteract these shortcomings.
Many financial institutions now offer such an annuity that conforms to the default regulations, and balances retirees’ need for income security with their desire to leave a legacy to their loved ones. This unique solution is known as a hybrid annuity: a life (or guaranteed) annuity inside a living annuity.
A hybrid annuity gives investors more allocation options than a standard annuity. It allows investors to choose how they want to allocate assets. Currently investors have the choice of investing in three different balanced funds within the guaranteed living annuity. They can then skew their assets to more conservative, fixed-return investments that offer a lower but guaranteed rate of return, or weight them toward more volatile variable annuity investments that offer the potential for higher returns in the remaining living annuity part.
The one-product solution hosts both a living annuity and guaranteed life annuity in your chosen configuration: for example 40% guaranteed and 60% living annuity. The future annuity income escalations (from the guaranteed annuity portion), rest on personalised portfolio construction and return results, which allows for flexibility and higher annual income escalation. The hybrid option also provides for partial capital conversion from an existing living annuity at any given time and, compared with a living annuity, provides a much more transparent and comparable cost structure.
Other benefits include the fact that the remaining investment capital in a living annuity can still be bequeathed to beneficiaries and the medical underwriting available on some guaranteed life annuities could now result in a higher monthly annuity income payment from the insurer.
So, for example let’s say an investor’s total retirement savings amount to R1 million and, like most people have done, it is fully invested in a living annuity that offers no longevity protection. There’s a very real risk of funds running out before death. Now, if the investor had invested 50% of his/her retirement portfolio in the lifetime income asset class and the other 50% in traditional asset classes – such as equities, bonds and cash – more than 90% of their lifetime spending needs should be met. The proportions will, however, depend on individual circumstances and goals, which should be discussed with a financial advisor.
Sygnia and Allan Gray were some of the first organisations to launch a hybrid product, which combines the benefits of both a living and a life annuity: guaranteed income for life and capital to invest and access for emergencies. With this ForLife Living Annuity product, the specialist retirement income company – Just Retirement Life – handles the compulsory annuity and Sygnia and/or Allan Gray handles the living annuity portion.
The lifetime income fund, as a specific unitised asset class, pays an income while the investor is alive. This essentially enables advisers to holistically review an investor’s circumstances and within one product trade-off and balance the two competing goals in retirement. It’s only the percentage allocation between the traditional asset classes and the lifetime income fund that will differ.
Investors can choose to have any percentage of the portfolio, from 0% to 75%, invested in the lifetime income asset class, which provides an income for life and the income depends on the performance of the balanced portfolio.
An existing living annuity (not a guaranteed annuity) can be converted to a hybrid annuity.
Like any investment choice, there are drawbacks to hybrid annuities. They allow for a once-off option at retirement to split savings between the life and living annuities. Investors can add to the hybrid annuity, but the guaranteed portion will be insured at the rate and date when the addition is made and not at the initial rate when the investment was started. For this and other reasons it is best to consult a qualified and experienced financial advisor to set up a financial plan best suited to individual needs.