Navigating annuities: making it easier to choose best pension plan
Tools and blended annuities are assisting people approaching retirement make better financial decisions
South Africans approaching retirement worry about making the right choice of pension plan.
This was highlighted in research Nedgroup Investments did recently before launching a new tool it hopes will help retirees not to make the wrong choices on pension plans and leaving an inheritance to children, especially as many retirees have limited retirement savings.
There is currently an increased focus from financial advisers and product providers in assisting retirees make better choices about their future cash flow.
Quaniet Richards, head of institutional at Nedgroup Investments, says most people do not have a detailed understanding of how their decision could affect them in the years to come.
Investing in a living annuity and drawing a pension from the investments is SA retirees’ most popular choice.
But drawing an unsustainably high level of income, poor returns in the early years of your retirement and longevity can all result in the investment amount dwindling sooner than expected.
When you reach the maximum you can draw — 17.5% of your capital — you can no longer increase your income to match inflation.
You can also make mistakes when choosing an annuity that provides a guaranteed income for life, particularly when it comes to choosing the level of increases and a pension for a surviving spouse.
Three providers of living annuities, Sygnia, Alexander Forbes and Glacier, already enable retirees to buy a guaranteed income with some of their savings in what is known as a blended annuity.
Insurance in reverse
Deane Moore, CEO of Just, which provides the income for life fund option on the Sygnia and Alexander Forbes living annuities, says you should use a guaranteed annuity to cover your essential expenses. A with-profit annuity’s increases are linked to investment returns.
Investments in the living annuity that expose you to greater risk, should be used for less essential spending — as the investment returns and your drawdown allow — and to leave an inheritance to your children, he says.
These blended annuities provide the certainty of a life annuity and the flexibility of a living annuity and allows you to “top up” the life annuity within the living annuity later in life should your income needs increase, he says.
Glacier has also built a tool for advisers to assist you to optimise your income using its living annuity and lifetime income plan.
Rocco Carr, business development manager for Glacier, says there is no single suitable pension plan for everyone as it depends on your circumstances and investment cycles.
From 2009 to 2015, for example, living annuities may have been a better choice as guaranteed annuities could not give you the same returns you could earn from a low equity multi-asset fund, he says. Now, however, the guaranteed rates are better and it may be a good idea to lock in this guaranteed income.
Nedgroup Investments’ Living Annuity Plus is the latest blended annuity on the market. It introduces a different approach that allows you to choose income top ups throughout your retirement, the cost of which is recouped from your remaining capital at retirement.
The benefit operates as insurance in reverse — you enjoy the benefits up front and pay at the end, Tracy Jensen, senior investment analyst at Nedgroup Investments, says.
The top-ups begin as a small percentage of your capital but the percentage increases as you age. This will benefit you as long as you manage the rate at which you draw a pension, but not if you draw high amounts and deplete your capital quickly, Jensen says.
For example, assume a 65-year-old man, who invests R1m in the annuity and draws R5,000 a month, is willing to sacrifice 25% of the remaining capital upon his death to secure monthly capital top ups during his life.
An amount of R3,500 will be added to his annuity savings in the first year. The top-up percentage increases every year. By age 75, he would receive a top up of R6,200 added to his savings, assuming he takes his pension from the returns and still has the R1m invested.
If at any time you need to increase your top ups, you can increase the amount of the residual capital you are willing to sacrifice. For example, if the man who invested R1m reached age 75 and decided to sacrifice another 20% of his residual capital, he would receive a larger top up of R11,200 that year, which is almost double the R6,200 he would have received, Jensen says.
The top ups enhance your capital and protect you against outliving its ability to provide an income, Jensen says.
If you are approaching retirement, Nedgroup Investments gives you free access to its planning tool and free virtual consultations with a retirement coach.
The MyRetirement Solution tool generates a plan that you can revisit at any time. The plan maximises your tax benefits if you draw a lump sum at retirement and recommends the best annuity or blend of annuities for your circumstances.
If a guaranteed annuity is best, the tool will show you the indicative rate for such an annuity, which you will have to buy from another provider as Nedgroup Investments does not sell guaranteed annuities.
If a living annuity is suitable, the tool recommends a sustainable income level and the benefit of the top-up payments if you are willing to sacrifice some of the residual capital.
Nedgroup’s living annuity has a choice of 15 underlying Nedgroup funds including its popular low-cost, passively managed, multi-asset funds. You do not have access to funds from other managers as you do on other investment platforms.
Jensen says many people have no idea how much income their savings will generate. After using the tool they often revise their plans about how much of an inheritance to leave to their children or make more effort to pay down debt before retirement.
Jensen says back-testing of Nedgroup’s Living Annuity Plus shows it delivers the same or better outcome in 90% of scenarios when compared to a blended living and with-profit annuity with the same income level and income increases.
Carr says many advisers are selling guaranteed annuities with life cover to guarantee an inheritance on death. However, the annuities sold are often level annuities that provide a pension that does not increase and can leave retirees who live longer with a huge problem, a shrinking after-inflation income.
A level annuity starts off higher, but an inflation-adjusted, escalating annuity catches up within eight to 10 years. If managing your income stream into perpetuity is the aim, you should seriously consider an escalating annuity, Carr says.
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