Deciding on a living annuity or a guaranteed life annuity need not be an either-or choice. You can now combine the two to achieve a sustainable income and a legacy. Picture:
Deciding on a living annuity or a guaranteed life annuity need not be an either-or choice. You can now combine the two to achieve a sustainable income and a legacy. Picture:

Many South Africans have effectively been gambling with their life savings by choosing to draw a pension from a living annuity with no longevity protection and without being rewarded for the higher risk involved.

Actuary Bjorn Ladewig, from retirement product provider Just, says this is because living annuities have generally underperformed with-profit guaranteed annuities since 2006.

The company's recent survey, Just Retirement Insights, shows that 89% of retirees want a lifetime-guaranteed income. Yet, according to the Association for Savings and Investment SA (Asisa), 92% of retirement money is invested in living annuities.

There is renewed interest in traditional guaranteed life annuities as the retirement industry scratches its head to solve the crisis that results in fewer than one in 10 South African retirees receiving a sustainable income in their golden years.

Living annuities are popular because they provide retirees a sense of ownership and control, says Warren Matthysen, principal consultant at Alexander Forbes Investments.

They also appear reasonably easy to understand because you earn investment returns on, and draw, an income benefit off the capital you invest. Any capital left when you die is available for your heirs.

Many investors see the flexibility and choice that living annuities offer as desirable, he says.

But "the harsh reality is that those retiring do not have enough savings to sustain their income for life and their desire to leave a legacy will ironically result in them becoming dependent on their family or the state", Ladewig says.

You may not face this challenge if you are able to live on an annual income equal to the broadly accepted figure of 4% or less of your retirement savings, but the average retiree needs to draw more, Roenica Tyson, investment product manager at Glacier by Sanlam, says.

Matthysen says living-annuity investors may be unaware of the cost of providing for a legacy - one of the key reasons that many choose a living annuity - at the expense of their future income.

The answer for many retirees is to use a combination of a living annuity and a guaranteed life annuity to achieve the twin goals of a sustainable income and a legacy, Tyson says.

In a paper presented to the annual convention of the Actuarial Society of SA, Matthysen calculated the cost of the future income and legacy to heirs.

Assume a 65-year-old man makes a R1m investment into a living annuity and draws an income starting at R52,000 a year (5.2% of his capital) and which increases at 6% a year for rest of his life (assuming an investment growth of 11% a year). The cost of the future income stream amounts to only R570,000. This means that R430,000 of the original R1m is funding the legacy and is not being used to provide an income.

Matthysen said living-annuity investors need to properly understand the cost of leaving a legacy.

Deane Moore, CE at Just, says the starting point for a person retiring and wanting to use a combination strategy, is to calculate your annual expected costs in retirement which should include food, utilities, medical, transport, insurance and the ongoing costs of retirement accommodation.

A guaranteed pooled product, such as a with-profit life annuity, can offer better returns at lower risk than a living annuity, because investors in the pool that survive to the end of each year benefit from the pot of money that stays behind in the pool when some of the other investors die, Moore says.

In this way the pool shares the risk rather than the individual having to provide for that risk, as in the case with a living annuity.

What you are getting as an investor in a pooled product is a return from your invested assets plus an additional return from the assets of those who die early.

The longer you live, the greater your additional return from a guaranteed annuity, he says.

Shaun Duddy, product development manager at Allan Gray, says combining living and guaranteed annuities allows you to better utilise and trade off the different characteristics of each.

He adds the industry has some way to go still in equipping financial advisers and annuity investors with the necessary information and tools to combine the two.

There are, however, some options available to retirees who want to benefit from both types of annuities.

Alexander Forbes, Sygnia and Glacier now offer a living annuity with the option to use a portion of your investment to provide a guaranteed annuity income.

In the Alexander Forbes and Sygnia products you buy units in the guaranteed annuity as you would buy into other underlying funds.

The guaranteed annuity is a with-profit one provided by Just that you can use to guarantee an income to cover your essential expenses regardless of how investment markets perform or how long you live.

The lifetime income increases each year roughly by inflation and the increase is derived from the above-inflation investment returns generated by Alexander Forbes or Sygnia asset managers.

Glacier by Sanlam's Investment-Linked Lifetime Income Plan provides a lifetime retirement income that is linked to the growth of an underlying investment portfolio. Unlike typical guaranteed annuities, you get to choose the underlying unit trust funds and the income is linked to the performance.

As Glacier's Investment-Linked Lifetime Income Plan will not provide a legacy for your heirs, you can provide for a spouse or dependants by adding a guaranteed income payment term (for up to 15 years), or by adding life assurance to the policy, Tyson says.