YOUR MONEY: Guaranteed pensions vs living annuities: what to pick
The choice between a guaranteed annuity and a living annuity typically comes down to the requirements and circumstances of the individual investor
22 September 2022 - 05:00
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Individual needs are key when retirees weigh where to put their pension savings. Picture: 123RF
Question:
With growth and inflation pressures, what are your thoughts on guaranteed pension funds vs a living annuity? My thoughts are that with a living annuity, the fund needs to perform at a minimum of 12%-13% before inflation to sustain 30 years with a maximum drawdown of 4%-5%, and this is very conservative. Is there a website that reports guaranteed annuity rates?
— Benji P
Answer:
The reader asks two important questions. First, the low-growth, high-inflation environment we find ourselves in certainly points to a higher allocation to guaranteed annuities, especially those with built-in inflation protection. These annuities increase by the official inflation rate, so pensioners will earn a higher income as a result. The low-growth environment points to lower expected returns from assets such as equities and property. Over time, however, equities tend to offer a return above inflation. There’s usually an adjustment period as we move from a low-inflation to a high-inflation environment, but equities typically deliver an annual return of inflation plus 6%-7%.
The choice between a guaranteed annuity and a living annuity typically comes down to the requirements and circumstances of the individual investor, rather than expected market returns. Both are post-retirement income products which offer different propositions. Guaranteed annuities offer a guaranteed income stream for the retiree’s life, irrespective of how long they live. Living annuities pay an annuity based on the fund value and the retiree’s chosen income drawdown rate. An annuitant can draw down between 2.5% and 17.5% of capital as an income. They take on market risk and may very well run out of capital (and therefore income) before the end of their life.
Guaranteed rates have finally started trending higher, market returns have been low since September 2014, and retirees are living longer
The choice comes down to the retiree’s preference for either income security or leaving a legacy. With retirement money, investors often have to choose one or the other.
In the past two decades there has been a significant move to living annuities, and by the end of 2016 90% of flows went in that direction. It appears this trend is reversing, with an estimated 20%-30% of flows in 2020 going to guaranteed annuities. This makes sense, since guaranteed rates have finally started trending higher, market returns have been low since September 2014, and retirees are living longer.
To address the reader’s comment that a living annuity needs to earn a minimum of 12%-13% to sustain 30 years of income drawdown, he is correct. Two variables affect income sustainability: drawdown rate and portfolio return. The table assumes income is increased at 6% a year. Only six of the 35 combinations shown result in income lasting more than 30 years.
When the reader is ready to start taking income, he should obtain quotes from several insurers as income rates can differ by as much as 20% at times. He also needs to choose the correct guaranteed annuity, considering issues such as guaranteed term, spouse benefit and increasing annuity. There is also the option of a new-generation hybrid annuity, combining living and guaranteed annuities in one product.
Support our award-winning journalism. The Premium package (digital only) is R30 for the first month and thereafter you pay R129 p/m now ad-free for all subscribers.
READER QUESTION OF THE WEEK
YOUR MONEY: Guaranteed pensions vs living annuities: what to pick
The choice between a guaranteed annuity and a living annuity typically comes down to the requirements and circumstances of the individual investor
Question:
With growth and inflation pressures, what are your thoughts on guaranteed pension funds vs a living annuity? My thoughts are that with a living annuity, the fund needs to perform at a minimum of 12%-13% before inflation to sustain 30 years with a maximum drawdown of 4%-5%, and this is very conservative. Is there a website that reports guaranteed annuity rates?
— Benji P
Answer:
The reader asks two important questions. First, the low-growth, high-inflation environment we find ourselves in certainly points to a higher allocation to guaranteed annuities, especially those with built-in inflation protection. These annuities increase by the official inflation rate, so pensioners will earn a higher income as a result. The low-growth environment points to lower expected returns from assets such as equities and property. Over time, however, equities tend to offer a return above inflation. There’s usually an adjustment period as we move from a low-inflation to a high-inflation environment, but equities typically deliver an annual return of inflation plus 6%-7%.
The choice between a guaranteed annuity and a living annuity typically comes down to the requirements and circumstances of the individual investor, rather than expected market returns. Both are post-retirement income products which offer different propositions. Guaranteed annuities offer a guaranteed income stream for the retiree’s life, irrespective of how long they live. Living annuities pay an annuity based on the fund value and the retiree’s chosen income drawdown rate. An annuitant can draw down between 2.5% and 17.5% of capital as an income. They take on market risk and may very well run out of capital (and therefore income) before the end of their life.
The choice comes down to the retiree’s preference for either income security or leaving a legacy. With retirement money, investors often have to choose one or the other.
In the past two decades there has been a significant move to living annuities, and by the end of 2016 90% of flows went in that direction. It appears this trend is reversing, with an estimated 20%-30% of flows in 2020 going to guaranteed annuities. This makes sense, since guaranteed rates have finally started trending higher, market returns have been low since September 2014, and retirees are living longer.
To address the reader’s comment that a living annuity needs to earn a minimum of 12%-13% to sustain 30 years of income drawdown, he is correct. Two variables affect income sustainability: drawdown rate and portfolio return. The table assumes income is increased at 6% a year. Only six of the 35 combinations shown result in income lasting more than 30 years.
When the reader is ready to start taking income, he should obtain quotes from several insurers as income rates can differ by as much as 20% at times. He also needs to choose the correct guaranteed annuity, considering issues such as guaranteed term, spouse benefit and increasing annuity. There is also the option of a new-generation hybrid annuity, combining living and guaranteed annuities in one product.
Visit www.masthead.co.za/annuity-investment-rates/ for annuity rates of various insurers and products.
— Craig Gradidge, investment and retirement planning specialist: Gradidge Mahura
Send your questions to yourmoney@fm.co.za
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