Picture: 123RF/DAVID FRANKLIN
Picture: 123RF/DAVID FRANKLIN

If you are retired or close to retirement and have been doing some reading about the best options for your retirement money, you might be very confused and worried. 

First, returns from investments have been poor over the past five years and some commentators are slating living annuities as bad investments. This is a complete change from 10 years ago when living annuities were the default for most retirees. 

Guaranteed pensions, also known as life annuities, are the alternative to living annuities and these have been criticised for decades. 

I see guaranteed annuities as an insurance salesperson’s best friend because they generate big upfront commissions and require no additional work from the person who sold you the product. So, what should you do with your retirement fund?

Life annuity

If you have been contributing to a retirement fund and are getting ready to retire or have already retired, you generally have two main investment options for your retirement fund: a guaranteed pension (life annuity) or a living annuity. 

Guaranteed pensions have been around for decades and every few years or so the insurance companies give them a new lick of paint and try to sell them as some new, innovative retirement option. 

Older advisers, and especially those with a background in selling insurance, love guaranteed pensions. 

I suspect there are a few reasons for this. First, once an investor has bought a guaranteed pension, the terms of the contract are fixed and there is not much work required from the adviser on an annual basis. Second, guaranteed-pension providers pay chunky upfront commissions to advisers. This is always attractive to salespeople as they sell the product and move on to the next deal. They don’t have to service the client and don’t have to explain poor investment growth when markets are performing badly. 

Another reason advisers like guaranteed pensions is that it stops clients from destroying their retirement money by withdrawing too much every year or by making bad investment selections within the living annuity. This I agree with, and find it especially appealing for investors who lack discipline with their spending. 

Living annuity

The scare-mongering from older insurance salespeople who are painting living annuities as the root of all evil in the retirement industry is quite concerning. This tactic has certainly borne fruit in the past few years, with even the regulators and government seemingly buying into the idea that guarantees are best. 

The recent regulations around default annuitisation could easily have been written by insurance lawyers and actuaries aiming to increase business for the insurance industry. To me, much of the regulation seems designed to eliminate the role of independent financial planners in favour of guaranteed pensions sold by insurance companies.

Financially educated investors, those with enough capital or people who use a proper financial planner might find that living annuities are their best option. 

Living annuities offer flexibility to select and change investments to suit your overall portfolio. For instance, if you have a personal share portfolio and would like to balance this with some exposure to bonds and listed property, you are able to do this within a living annuity. 

In addition, if you would like to hedge a greater part of your retirement money in international markets, you can invest a large portion of your living annuity in offshore “feeder” unit trusts. These are funds that are fully invested overseas but are priced in rands. This means you would benefit from a depreciating rand or rising international markets but you would still be paid your income in rands.

In addition, if you plan to leave assets to your children, a living annuity is one way of doing so. You can get huge estate duty savings when you leave a living annuity to your children and no executor’s fees are charged on these investments. With a guaranteed annuity, it is very possible that no money from these products will be transferred to your children.

Living annuities do have flaws. First, investors can withdraw a large amount of money from these investments every year (17.5% of the capital) if they choose to do so. 

In addition, clients can invest 100% of their living annuity in cash or nearly 100% in shares. Either of these options could lead to terrible investment outcomes. 

These problems are serious but can be mitigated or eliminated through proper advice and product selection at retirement. 

In addition, it is imperative that investors monitor their living annuities or use a qualified adviser to assist them. This is especially important when markets are performing badly as it would be very tempting to make big changes at the wrong time.

A combination of a guaranteed and living annuity is also a possibility, but may not always be the right option for you.

Be slow to switch

I prefer living annuities for most people who have enough capital at retirement. Good financial planners will always be comfortable to manage their clients’ emotions through difficult markets. The recent poor performance from SA unit trusts should not be the reason for investors to move away from living annuities. 

However, people in the unfortunate position of retiring with insufficient capital could consider a guaranteed annuity as they are likely to get a higher initial income and might not have the luxury of leaving money to their children. 

If you are worried about your living annuity, don’t switch to a guaranteed annuity automatically — ask for alternatives and consider all your options before making a change. You might find that your best solution is to persist with your current solution until markets recover.

• Warren Ingram is a wealth manager at Galileo Capital and former Financial Planner of the Year. You can follow him on @warreningram