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Getting the most out of annuities

It’s not always an either-or choice.

Anyone who has saved money in a pension fund or a retirement annuity has to make a decision when they reach retirement age. At least two thirds of the money they have saved has to be used to secure themselves a monthly income.

This must be through a living annuity, or a guaranteed annuity. However, it’s important for investors to understand that they are not restricted to choosing one or the other. It is possible, and even often advisable, to use both.

“As an individual, your lowest-risk annuity choice is always buying a guaranteed annuity that starts off providing you with the amount of money you need and escalates every year with inflation,” says Mark Lapedus, divisional director for product development at Liberty. “Then, no matter how long you live, you should always meet your income objectives.

“But while that is a great idea, some people can’t afford that from day one, because the guaranteed income that they can purchase doesn’t meet their needs,” he explains. “They may also want to leave money behind, or some other reason. They therefore have to make use of a living annuity for that.”

Since living annuities are more flexible, it is possible to draw a higher income. As many South Africans have not saved enough, this becomes necessary for a lot of people.

This is not, however, without risk, because drawing too much could mean that your money runs out too quickly. This is why it makes sense at least use some of your capital to secure a guaranteed income for life.

“If I do a cash flow projection and know the amount of money I will need every month, I can ask myself what is the minimum amount I need to ensure that my basic needs are provided for,” says Lapedus. “I can then buy a guaranteed annuity for that portion of my expenses that will at least give me some sense of security. I can then take some risk with the remainder.”

Many people also choose living annuities because they want to leave money to their heirs. However, this should never be a primary consideration. If this is money you have saved for your retirement, then that is what it should be used for.

“If I don’t have enough money to look after myself, then I really shouldn’t be worrying about children and grandchildren,” says Lapedus. “I should be maximising the likelihood that I have a decent retirement, not worrying about what I am going to leave behind.”

Changing allocation over time

Another benefit of keeping money in a living annuity is that it is possible, at any time, to move some or all of your capital from a living annuity into a guaranteed annuity. You can’t, however, transfer funds the other way. 

“It’s easy to move from a living annuity to a guaranteed annuity, and there could be many cases where it makes sense to do so,” Lapedus argues. “Particularly because the older you get, the more attractive a guaranteed annuity becomes.”

The life insurers who underwrite guaranteed annuities use two main factors to calculate the income they offer – your age and the current interest rates. The older you get, the higher the income you will receive for the same amount of capital, and the higher the current interest rates, the more the insurer will able able to offer you.

Your circumstances will also change through the years of your retirement, and this will impact on the income you need.

“Your expense requirements may change, perhaps due to the death of a spouse or a change in your living situation,” Lapedus says. “While you may not have been able to afford a guaranteed annuity from the start, you may therefore be able to do so at a later stage.”

He recommends checking regularly to see what level of guaranteed annuity you can purchase with the capital you have in your living annuity, and whether you can give yourself peace of mind.

“It’s part of an ongoing process to say what is the cost of a guaranteed annuity, and how does that compare to my income needs?” says Lapedus.

Brought to you by Liberty.

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Converting from a Living Annuity to a Life Annuity will become VERY attractive if we reach a situation where interest rates are increased to levels that long-term investments simply cannot match. A prime example of this was when the prime interest rate reached around 25% during the early part of this century. If you could get locked-in to a Life Annuity with a 20-25% Annuity rate then you should JUMP at that opportunity.

Remember that for a Life Annuity to be a viable choice for a married person, the JOINT and Last Survivor option should be taken to guarantee the income for a surviving spouse as well. This automatically reduces the amount of the monthly income. The more guarantees you apply to Life Annuities, the lower the levels of income are.

Current rates are still not high enough to encourage this move as the Annuity rates are further drastically reduced if you select one with a guaranteed annual increase.

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