Choosing between a life annuity and a living annuity for retirement

‘At Momentum we think that advisors and clients should really be considering how to match a client’s expenses during retirement’: Fareeya Adam – Momentum Investments.

CIARAN RYAN: For many people the biggest financial decision they face when they retire is how best to use their accumulated retirement savings to provide them with a sustainable income in retirement. Now, retirement is a complex event and it can be overwhelming for many people. Making the wrong choice about retirement can literally mean the difference between living in comfort or having to continue working past retirement age.

Joining us to help clarify some of the issues surrounding retirement is Fareeya Adam, head of retail product solutions at Momentum Investments.

Hi, Fareeya. Thanks for joining us. Traditionally, people have a choice between a life annuity and a living annuity, each with its own unique features and rules. So maybe just explain what these are for those of our listeners who don’t know, and the benefits of each. Perhaps let’s just start with the living annuity.

FAREEYA ADAM: Sure. Hello everyone. With a living annuity the main theme is flexibility. The client can choose investment components to suit their investment strategy, and they can tailor their income. Regulation requires a client to choose an income level between 2.5% and 17.5% of the investment value. But this can be adjusted every year.

Now, one of the key consequences of a living annuity is that the client typically takes on all the risk. For example, if markets don’t grow as expected and inflation is higher than predicted, there is a risk that the income a client can draw starts to fall in real terms. The money also needs to last for a person’s lifetime. So, if you don’t strike the right balance between living and life expenses, or you are one of those people who live for a very long time, there may be a risk of running out of money to pay for even the bare necessities.

Now, investment and inflation risk, and medical advances that result in people living longer, are really out of all our individual control. So clients choosing a living annuity often think that the main risk is to die earlier than expected, in which case they want to be certain that they can leave some money for their beneficiaries. This is because the remaining capital in a living annuity is paid out to the beneficiaries when a client passes on.

But what people often understate is the risk of negative inheritance. So if a client lives longer than expected and runs out of money, instead of leaving an inheritance to [their] dependants, which is often highlighted as one of the main benefits of a living annuity, [they] in fact become dependent on [their] family members and this becomes a negative inheritance.

CIARAN RYAN: Okay. Let’s talk about the life annuity. That’s an interesting one. For people with a living annuity, living too long can result in a negative inheritance. Does the same apply with a life annuity?

FAREEYA ADAM: Not at all. The life annuity pays a guaranteed income for life, so it’s really a very good match for a client’s basic expenses. The client is not exposed to market volatility or the risk of living longer than expected, because the income is paid out for life. These risks are actually all born by the insurance company, and a life annuity is the purest form of protecting income because there’s no risk to the client. It can be personalised to a degree by adding a level of income increases, by adding a guaranteed term, or choosing to use a joint life option. But on the other hand, it doesn’t have the flexibility that we spoke about with the living annuity. Some people require this flexibility to provide for more variable living expenses. Typically there’s no capital amount available on death to provide for any inheritance.

CIARAN RYAN: I guess we should not forget that every person will have somewhat different needs and different objectives. So retirement planning is a very personalised thing, and you touched on that.

What we also know is that South Africans are poor savers and they often start to confront retirement savings only when they get closer to retirement age, often in their 50s. What are different needs that people should be planning for?

WATCH: Enhance your retirement income planning webinar.

FAREEYA ADAM: Definitely, as you say, a poor savings culture – together with the impact of poor investment behaviour or investment returns – is definitely a real risk to retirees. At Momentum we think that advisors and clients should really be considering how to match a client’s expenses during retirement.

Now, there are different categories of expenses. Firstly, there are your basic life expenses that include things like having a place to live, medical aid, groceries – really your regular essential spending that you cannot do without. Then there are the living expenses, which are the things that we all like to do, like paying for a holiday, starting a small venture, contributing to a life event. But these living expenses must always come after your life expenses.

The third need is really the need to leave an inheritance. It often features very strongly, this need to leave an inheritance, but it should really come after a client has covered the rest of [their] expenses. Now the relative importance of these needs is a function of how much a client has saved before retirement. The savings could be either inside a retirement savings product, or outside through other asset accumulation. But this is the real need of a client during retirement.

Now a life annuity is typically best suited to meet a client’s life expenses, those that [they] cannot afford not to have money for. The growth assets typically included in a living annuity are a good match for a client’s living expenses and the need to leave an inheritance.

CIARAN RYAN: Okay, let’s wrap this all together. Even if people decide to use some of their retirement savings to purchase a life annuity, and some to invest in a living annuity, they can end up with two separate retirement-income products – and that makes it difficult to manage their income during retirement. Is there a solution to this?

FAREEYA ADAM: Most often people just choose one or the other. In most cases the sharing-of-risk decision is made at the time of retirement, so it becomes a once-off decision that affects the client’s income for the rest of [their] life.

Now those who have split their retirement savings between a living and a life annuity typically have to set up two contracts, which tends to be a cumbersome process. We don’t see it happening very often.

But Momentum Wealth has recently reimagined our living annuity solution, which is called the ‘retirement income option’. An advisor can now include a guaranteed income inside of the living annuity as one of the investment components. [The advisor] achieves this through investing a portion of the assets in our new guaranteed annuity portfolio.

So you can still personalise the income by choosing annual income increases to protect the real value of the client’s income and reduce [their] inflation risk. And you can also partially meet the need for an inheritance by incorporating guarantee terms and joint life options, but it’s a protected portion inside of your living annuity. The rest of the living annuity assets can then continue to be invested in a variety of investment components to increase the capital value and offer more flexibility of income. The more it grows, the more optionality a client will have for drawing an income and for leaving a legacy.

So effectively what we are offering is growth and protection of income in one solution – with the balance between the two left to each individual.

In addition, a client and advisor don’t have to make this decision only at retirement.

With the Momentum solution they can choose when to protect some of the income and how much they want to protect at any point during the client’s retirement.

CIARAN RYAN: All right, Fareeya, here’s a final question. Where can people go to get more information about your new solution at Momentum?

FAREEYA ADAM: The best place to go to is our website and look out for the Reimagined Retirement Banners.

CIARAN RYAN: Fareeya Adam, head of retail product solutions at Momentum Investments, thank you very much for your time.

FAREEYA ADAM: Thank you for having me.

Brought to you by Momentum Investments. 

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