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18 September 2013
Choosing the right annuity can mean the difference between a comfortable life and financial despair when you retire. But how do you choose between a living and a guaranteed annuity? And what is the difference between the two? Nicolette Dirk spoke to the experts to help you make the best choice.
The difference between a guaranteed and a living annuity
Nico Coetzee(pictured), executive of business development at PPS investments, says a guaranteed annuity is offered by an insurer and provides a guaranteed, predetermined income for the rest of your life. “This income amount will be set and fixed based on prevailing interest rates at the time of your investment. The decision to invest in a guaranteed annuity is final and any remaining retirement capital you may have at the time of your death is kept by the insurer,” says Coetzee.
He says a living annuity provides a vehicle through which to invest your retirement capital in unit trusts. You can choose exactly how your savings are invested, how much you’d like to draw from your savings as income and how frequently you’d like to receive your income payments.
“You can also change your unit trust selections at any time, can change your regular income amounts once a year and can completely withdraw your investment (or transfer to a guaranteed annuity) at any stage if you later choose to. Any remaining retirement capital you may have at the time of your death is paid over to your chosen beneficiaries,” says Coetzee.
Coetzee adds that to choose between these two types of annuities, investors need to evaluate their income requirements and personal risk profiles.
What are the pros and cons of a guaranteed annuity?
Coetzee says a guaranteed annuity offers a sense of security: No matter what happens in the market, your income is guaranteed.
“It therefore requires minimal time and effort to manage your retirement savings, as you don’t need to monitor markets or stay abreast of economic developments to position your portfolio appropriately,” says Coetzee.
However, he adds that this also means that you receive no exposure to potential market growth, which could enable you to grow your savings and possibly provide for greater income withdrawals. Investors also need to consider that in a guaranteed annuity there is no value at death. As the insurer who offers your policy bears the risk that you might live for a long time after retirement, it also keeps any residual assets if you die shortly after retiring.
Niel Fourie, public policy actuary at the Actuary Society of South Africa, says it is a misconception about guaranteed annuities that the life insurance company benefits.
“This is not the case. Guaranteed annuities apply the law of insurance whereby a pool of people share in the risk. The capital left behind by a member of the pool, who died early, is used to fund members who live longer than expected,” says Fourie.
What are the pros and cons of a living annuity?
Coetzee says a living annuity allows you to invest your accumulated retirement capital to generate further returns. This involves greater investment risk and greater involvement with your investment portfolio.
“However, it also gives you the potential to grow your retirement capital further. A living annuity allows you to decide how your retirement capital is invested. You then structure your own income withdrawals, with the flexibility to update these particulars on a regular basis. You are also able to make changes to your investment portfolio at any time and can therefore respond to changing market conditions,” says Coetzee.
He adds that although it may not be your primary objective when investing your post-retirement savings, the residual value of your capital upon your death is payable to your chosen beneficiaries. If managed efficiently, your living annuity can therefore have enduring value to these beneficiaries.
Fourie points out that one reason why living annuities are popular is because any capital left over at death is paid out to beneficiaries. But this comes at a price.
Fourie refers to a study done by Mayur Lodhia and Johann Swanepoel, two members of the Actuarial Society. The study shows that investors expecting to live well into their 80s will have to sacrifice up to 25% of their income to preserve some capital for beneficiaries.
“If the aim of investing in a living annuity is to draw a regular income as well as leave behind capital for beneficiaries, you will have to sacrifice a portion of your income,” says Fourie.
Which type of annuity will suit you?
Coetzee says a living annuity may be a more appropriate choice for investors who wish to exercise more control over their savings and seek the potential to generate further investment returns (even at potentially higher levels of risk and involving greater individual responsibility).
“A guaranteed annuity may be a more appropriate choice for investors who value certainty and would prefer to take on only very slight risk exposure, even if at the expense of potentially greater returns,” says Coetzee.
Fourie stresses that there is a need for both types of annuities. However an assessment of the pensioners’ needs should determine which product is sold.