Metropolitan Life

Choosing an annuity is not as simple as it appears – speak to a financial adviser for informed decisions and get a peace of mind

If you are one of the thousands of South Africans nearing retirement, chances are that you are considering your investment options post at retirement. According to South African law, a person can withdraw one-third of a retirement lump sum tax-free and must invest the remaining portion in an annuity, which hopefully is adequate to sustain a reasonable standard of living during retirement.

Essentially, if you’re considering your investment options you will be faced with two choices. The first is what is called a living annuity and the second is a guaranteed annuity.

Living annuities have become extremely popular over the past few years and more than 80% of South Africans who retire, opt for the living annuity option. It’s easy to understand why. Probably the most important factor is the level of income that an individual would be able to draw. According to regulation, a person may withdraw between 2.5% to 17.5% of the value of the investment per year. Furthermore, when a person dies, the remaining portion will pass over to the individual’s beneficiary. An individual normally has the option of switching his or her investment portfolio annually, which means they can investment in different investment classes like equities (shares), bonds, property and money markets (cash) – any combination of these and different combinations within these - depending on the product chosen.

Guaranteed annuities, by comparison, work on the principle that a person will receive a regular income until they (or in some cases their spouse) dies. In most cases, when an individual (or their spouse dies) payments stop. This means that that no money  will be paid out to beneficiaries unless a person had an explicit guarantee in place or life insurance built into the contract While living annuities offer an investor a suite of investment portfolios, there are many types of guaranteed annuities that will affect your income stream over time. For example, level annuities, offer investors the same monthly amount for the entire period of the annuity, escalating annuities offer an increase in monthly income set at a predetermined rate like the inflation rate or a with-profit annuity that guarantees your initial pension for the entire period but is linked to investment performance, which could result in above-inflation or below-inflation increases depending on investment markets.

The fact that eight out 10 endowment policies sold in South Africa are living annuities may suggest that it’s a foregone conclusion that these products are superior. However this isn’t necessarily true and a person nearing retirement should seek as much advice as possible in determining which type of annuity meets their individual requirement. . The key difference between a guaranteed annuity and a living annuity, is that both the investment risk and the risk of the fund drying up during retirement are borne by the client in a living annuity and not when invested in a guaranteed annuity. The investment risk is of particular concern given the current volatility on investment markets, and severe downgrades in market values, would result in a drop in the income that can be drawn from a living annuity. In essence, a guaranteed annuity provides a client with more certainty around their post-retirement income stream.

For example, if a person chooses a living annuity because of the flexibility to investment, one needs to be certain that they are going to get the best investment advice on an ongoing basis to make sure they achieve capital growth and do not erode the value of their annuity.

Research by Metropolitan showed that this is a very real risk. Company data (pre-retirement) shows that when an individual has the option of choosing their investment portfolio, which most retirement funds offer these days, nine out of 10 South Africans do not do so. This seems to be the case across the industry. In fact most of those who do, are often nearing retirement, and often switch to more aggressive and  risky investments after they realise that their pension payout is nowhere near to what they expected it to be.

The question is, if an individual did not play an active role in managing their retirement investment pre-retirement, which would have a been a substantial part of their life, will they now start making investment choices post-retirement, and will those choices be sensible?

Furthermore, people who reach the age of 100 (“centenarians”) are currently the fastest growing part of the population globally.

It is estimated that there are approximately 450 000 centenarians globally.

International statistics show the rapid increase in centenarians over the next 40 years:

•               USA: 72 000 (expect to have a 1 million in 2050)

•               Japan: 30 000 (expect to have more than 1 million in 2050)

•               UK: 9 000 (expect to have 40 000 in 2030)

•               China: 7 000 only (expect to have the most of all countries in 2050)

•               Spain: 10 000, Canada: 5 000, Italy: 5 000, France: 3 000

There’s a very real risk that many South Africans will also run the risk of outlasting their retirement provisions.

A recent industry study showed that more than two-thirds of South Africans thought that their retirement provisions would only last for 15 years. And of those, an overwhelming majority thought that their retirement provision is sufficient for ten years or less. 

These are some compelling reasons to consider all options more carefully. Probably the most important reason to consider a guaranteed annuity is that it provides a predictable income stream for the rest of your life. While some may argue that if you die within three months, your heirs will not be entitled to anything. This may have been the case in the past but most service providers these days offer options to pay out spouses, and other beneficiaries, in the form of a lump sum benefit or continuation of an income benefit.

In light of the current market volatility, financial advisers should be at the core of any financial planning decisions to ensure that you make the most suitable investment decisions, especially when looking at post retirement. Many who do not make use of a financial adviser at this juncture in their lives end up making uninformed decisions that may lead to dire financial consequences.