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Life and living annuities – and financial advisors

Wouter Fourie of Ascor Independent Wealth Managers recommends combining the two annuity types.
Picture: Shutterstock

SIKI MGABADELI:  We are focusing now on a debate taking place among financial advisers on living annuities and life annuities. Each of these is regulated in a certain way and has its own pros and cons. Maybe you are trying to figure out what to do at retirement. If you are in retirement right now, maybe you want to make a change and you don’t understand how each one actually works.

Wouter Fourie is MD at Ascor Independent Wealth Managers and joins us now. Wouter, thanks so much for your time today. Why is this a hot debate at the moment?

WOUTER FOURIE:  Siki, good evening. Yes, it is a hot debate. Just to clarify – living annuities and life annuities can only be purchased after retirement. So you build up until retirement, and then you need to choose.

The big debate at the moment is which is the best. The challenge that we are facing at the moment is, if you look at the history of living annuities and life annuities, living annuities are about 20 years in use by people, and we find that at this stage it becomes dangerous in terms of drawdowns on living annuities. Because we see the markets aren’t producing what they did in the past and people are used to drawing a lot of money out of these investments, we see a crisis coming. In the past three years we’ve had sideways movement on the market. People had been drawing 7/8/9/10% from their investments, and we are going to see these capital investments being depleted – and these people will be challenged in future.

SIKI MGABADELI:  Let’s talk about the real impact of that, when people have been used to drawing so much in the past and the market then stays straight – as it has over the past few years – and the impact that that has on people.

WOUTER FOURIE:  Living annuities, let me explain the way they work. When you go on retirement you’ve got a choice. One-third of your retirement annuities and your pension fund you can withdraw in cash, which gives you a certain portion which is tax-free. And with the other portion you are compelled to buy a guaranteed annuity or a living annuity.

Now the guaranteed annuity, also known as a life annuity, produces a monthly income. You give the money to an insurance company – it’s like a policy you buy – and they pay you a fixed amount for the rest of your life. The choice you have there is you can escalate the amount per month, or you can take a fixed amount.

Now the difference between the two is when you take a fixed amount, at the beginning you can draw a lot more from the pension. It pays you more. But if you’ve got the escalating amount, you start off with less. The danger in the choice between those two is that if you’ve got a life annuity your money stays the same for the rest of your life. So ten years ago R1 000 was a lot of money; today it’s dangerous.

SIKI MGABADELI:  That’s why we need to talk about the impact of inflation, and how that eats into your income and your quality of life.

WOUTER FOURIE:  Yes, that’s right. If we look at that specific product, about 20% of the pensions bought go into those products. The other 80% move into living annuities, where you have the choice to draw down between 2.5% and 17.5% of the capital. If you draw too much from the capital you will deplete the capital. You’ll find that your income will reduce as you get older.

We did a study with Allan Gray and we looked at the current situation, and the current [average] drawdown rate is sitting at about 7.8%. The danger is, if the markets give you 0% and you draw down 7.8%, you are starting to eat into your capital. That’s why we say people need to be disciplined when they look at this, and they need financial advice.

SIKI MGABADELI:  Let’s talk about financial advice. What is happening currently? Are people making the right decisions, because the other worry of course is that we are living longer.

WOUTER FOURIE:  That’s true. Longevity is a reality. Medical expenses. We see the medical fraternity helping us to stay younger, beautiful and live longer.

SIKI MGABADELI:  Which is great.

WOUTER FOURIE:  With its challenges, of course. Ja, we are getting older and we can even see it in our clients. They are getting older and we need to make sure that their capital lasts throughout this period.

So the danger that we see is that, when people buy these annuities without advice, the average drawdown rates are as high as 10%, whereas the drawdown rate of people going with advisors is 7% – which is still not fantastic, but at least it’s better than the 10%. And people buying it need to make their own investment decisions as well.

Now if you are very well qualified in investments, then maybe yes, you can manage things yourself. But just if you look at the choice of investments, there are 1 600 different unit trusts to choose from; it’s really tough to do it if you are not a specialist.

SIKI MGABADELI:  And are the specialists that people are relying on themselves well trained in the financial planning industry?

WOUTER FOURIE:  If you look at the financial planning industry, that’s a good question, because we also find that the registration requirements – if you are a financial planner you need to be registered with the Financial Services Board. There are about 140 000 financial advisors out there, but there are only about 4 800 CFPs, certified financial planners, people who actually have taken the time and effort to educate themselves, to get a post-graduate qualification and also to write a board exam to give financial advice.

So when you do need financial advice, I think the first stop would be to try and find out who is a certified financial planner, somebody with experience, ethics, [having done the] examination, and also part of the Financial Planning Institute of South Africa.

SIKI MGABADELI:  Then at least you are dealing with somebody who, as you’ve said, has made the effort. But if something goes wrong you can also probably complain.

WOUTER FOURIE:  That’s correct.

SIKI MGABADELI:  Okay. What sort of question, then, should people be asking about, firstly, life annuities – and then we’ll do living annuities.

WOUTER FOURIE:  The first thing is to look at the different options available, as you said. Life annuities versus living. The life annuity gives a guaranteed income for the rest of your life, but there is one downfall. It only covers your life. So if you pass away in five or ten years, that money is not there for your wife and kids to inherit.

SIKI MGABADELI:  So you can’t pass it on as an inheritance.

WOUTER FOURIE:  That’s right. There are some of those products that are structured, that give a ten-year guarantee – so if you pass away within ten years, it keeps on paying that money to your wife and kids. But after ten years it falls away.

You can also structure it to provide a certain income to your wife. So, if you pass away, then 50% goes to your wife for her life, usually at half the rate that you receive and the amount of money is a lot less than the level premiums. We find not a lot of people choose that, which is actually the better product if you look at the two.

Then if we move into living annuities, where you can draw down 2.5% and 17.5%, the danger there is if you go into that product and you don’t have the right investment portfolio, you can find yourself in a difficult position where you start drawing down into your capital too soon and too quickly.

So the advice then is to make sure that you sit with a financial planner to look at the different options and also to speak to more than one financial planner to understand the different options available. You also have different kinds of financial planners. We have financial planners who are tied to a specific company. Some of the green companies or the blue companies, whatever, are only allowed to sell their products.

And then you find independent financial advisers like us. We are not tied to any company and we can offer the best of breed to our clients.

SIKI MGABADELI:  That’s the other important  thing that I wanted to ask you about. Obviously in the past a lot of people went with people who went with brands, or a specific retirement house or insurance brand, and then were given branded products. Is someone actually then able to change that? Can you adjust when you are already in retirement, and have already sighed a document, looking at the older agreements that were signed in the past?

WOUTER FOURIE:  Yes. If we look at the life annuities, when you purchase a life annuity it’s for life. You can’t change it. The contract is fixed, and that’s it. If you go the route of a living annuity, you’ve got choices. You can actually move the investment from one company to another company. You are not tied for life. That’s why it’s called living – it lives with you. And if you pass away within the first 10 years or wherever, the money that’s left behind can be inherited by your wife and kids. What we find in the market is that most people would buy that product because of the money that’s available to be inherited.

The nice thing about living annuities is you can always switch from a living annuity into a life annuity, but not the other way around. So the life is stuck for life – that’s what you get and it’s with you. It’s not a bad thing, especially if you have a history of a family that gets very old. Maybe it’s a good thing to have a guaranteed income for the rest of your life.

SIKI MGABADELI:  With the living annuity, how often should you really look at things – at how much you are getting and how your investments are doing?

WOUTER FOURIE:  In terms of the Income Tax Act, which regulates the drawdown rates on living annuities, you are compelled to look at your income once a year, and you can change the percentage that you draw down only once a year. It’s called the anniversary date. So the day you go into the investment, next year on the same day it’s got its birthday or anniversary, and you can re-adjust that percentage drawdown. There we do recommend you sit with a financial planner to do that calculation to see how much you can afford to draw down at that stage.

So for all of us, when we get into retirement, the first thing you need to do is sit down and draw up a budget, because you need to know how much you need to earn after retirement, and you need to stick to that budget. That is usually the big challenge that we see with clients. They don’t budget. They go into retirement with huge expectations. They want to take the one-third and buy a new car and splash on a holiday, and that’s it. You need to realise that is your income for the rest of your life. You need to protect it.

SIKI MGABADELI:  That’s interesting because, as we were saying earlier, medical technology means we live much longer. How do you work out how much you are going to need?

WOUTER FOURIE:  Once again, with a decent budget you can actually do projections, to see if you project until age 90 or 92. You can see how long your capital will last over that period. So, once again, you need the help of a decent financial planner who can show you the graphs and the impact on your retirement planning.

SIKI MGABADELI:  What sort of trends are you seeing right now among retirees? Are they going more for life or for living annuities?

WOUTER FOURIE:  The stats show us that most people, about 80% of people, move into living annuities. I think the main driver behind it is the fact that, if you should pass away, there is money left for your kids and your family – which is not always the right reason. You need to look at your own circumstances.

What we do recommend is maybe a combination of the two, where you can take out the life annuity that gives you an income that escalates on a monthly basis, that covers your basic needs in terms of life costs, and you know it’s guaranteed, no matter what the markets do – fluctuations up and down. That stays fixed. And with the other portion you can go into a living annuity, which gives you the flexibility of adjusting your lifestyle. Sometimes you need to draw a bit more if you have difficulties in terms of medical costs, etc, and then you can reduce it again. The same with markets. If markets run, you can maybe take a bit more. And when markets are tough you need to pull back and cut on your budgets.

SIKI MGABADELI:  Do all forms of pension funds now require you to purchase a life or living annuity?

WOUTER FOURIE:  No. Only your pension funds and your retirement annuities.

SIKI MGABADELI:  And the provident funds?

WOUTER FOURIE:  Provident funds – not at this stage, because you can withdraw the full amount of your provident funds.

SIKI MGABADELI:  All right, we’ll leave it there. Thanks so much for your time. If people want more information, how do they get that?

WOUTER FOURIE:  They are welcome to visit our website, Ascor.co.za. We’ve got some beautiful webcasts there. You can go and read. There are a lot of articles and also publications that we do on a regular basis.

SIKI MGABADELI:  Thank you for your participation. Wouter Fourie is managing director of Ascor Independent Wealth Managers, talking to us about life and living annuities.

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