Amidst one of the fastest market crashes in the last century, there has been one investment that has gone unnoticed. Guaranteed annuities, also known as life annuities. Today you can get a guaranteed annuity that is 20% higher than before the Covid-19 market crash. This can be attributed to the spike in South African bond yields from 9.5% to above 11%. This presents retirees and some investors in living annuities with a window of opportunity amidst the current crisis.
Retirees invested in a pension fund or retirement annuity fund must buy a pension with two thirds of their fund value. Currently investors in provident funds do not have to buy an annuity. As part of retirement fund reform, National Treasury proposed the annuitisation of provident funds, whereby members will be required, upon retirement, to also purchase an annuity with two thirds of their fund value from March 1, 2021.
Advantages and disadvantages of a living annuity:
|You can select an income of between 2.5% and 17.5%.||If you draw too much income, you face the risk of capital and income reducing over time.|
|Assets can be invested into a range of investments aligned to your risk profile. You are not bound by Regulation 28, thus you can allocate a higher percentage of assets to offshore investments.||You are exposed to market risk; your income and capital is dependent on market movement|
|You benefit from good investment performance.||You are impacted by poor investment performance.|
|You can nominate a beneficiary who will inherit the balance of our assets.||You may live longer than expected, ending up with too little money to last until your death.|
|A living annuity can be converted to another; living annuity, hybrid annuity or a life annuity.|
If you invest in a life annuity, you can select from a range of annuity options and permutations including; level annuities, fixed escalation annuities (i.e. 5%), inflation-linked annuities and with-profit annuities.
The details of each of these permutations is beyond the scope of this article. It is however important for investors to ensure they understand the differences between these permutations i.e. the starting income from a level annuity can look very attractive, however as this does not grow with inflation, investors are left destitute in time as the value of their pension is eroded by inflation. It is sad, and shocking, that these annuities are proposed to investors, without a proper explanation.
Advantages and disadvantages of a life annuity include the following:
|Your pension is guaranteed for life and is not dependent on market conditions or movements. You do not have to concern yourself with market movement or investment decisions.||Life annuities have no flexibility, once selected you cannot make any changes.|
|Annual increases are guaranteed for life. Increases are as per your selected annuity option i.e. at a fixed rate off i.e. 5%, at inflation or aligned to market growth (with profit annuities).||There is no flexibility in changing your income, once the income and type of annuity is selected it can not be changed.|
|A spouse’s income and or a guaranteed period can be added. The guaranteed period can make provision for children should both spouses pass away.||Upon death, there is no capital left for beneficiaries.|
What income can I currently expect from a living annuity and a guaranteed life annuity?
The table below gives an indication of what income can be obtained by investing R1 million in a living annuity or a life annuity. It is important to remember that life annuity rates change weekly and currently the life annuity rates are benefitting from the exceptionally high bond yields. In the example below the Just annuity includes a 75% spouses’ annuity and the Old Mutual and Momentum annuities include 100% spouses’ annuity. Once you have established your specific need it is important to do a like for lie comparison of life annuities. The below provides an indication of the income that is available from different insurers compared to a living annuity from any one of the large financial institutions.
The living annuity drawdown rates used are as per the draft guideline from Asisa (Association of Savings and Investment). These draft guidelines have been developed to provide an indication of what income can be drawn to ensure the sustainability or longevity of a living annuity. With-profit annuities have proven to provide a higher level of income over time compared to an inflation linked annuity. The risk with-profit annuities pose is that there could be a year of low or “0” increases in income, this is specifically relevant in times of uncertainty, as we are currently experiencing. This risk can be mitigated by using a life annuity in combination with a living annuity through what is called a hybrid-annuity, or alternatively through the provision of an emergency fund.
Amidst the current crisis, investors can benefit from high bond yields, resulting in higher life annuities. By investing in a hybrid annuity, investors can benefit from the flexibility offered by a living annuity and the exceptional value, or higher income, available in life annuities.