Retirees advised to pick both a living and a guaranteed annuity for peace of mind. Your best bet for a sustainable retirement income is to combine a good value-guaranteed annuity with a well-managed living annuity, leading financial advisers agreed at a recent Financial Planning Institute (FPI) conference. A guaranteed annuity offered you "insurance" against the risks of outliving your retirement capital, but there were a number of things seriously wrong with these pensions, advisers said. Every member of a pension fund, retirement annuity and, in the future, possibly a provident fund, must at retirement use two-thirds of their savings in these funds to buy an annuity — a sum of money or pension paid to someone regularly. Most South African retirees choose to generate a pension using an investment-linked living annuity in which they must decide how to invest their lump sum and then what level of income to draw from the investments as a pension. But these annuities involve complex decisions on how the investments will perform and the level of income that can be withdrawn, and provide no guarantee that the income level can be sustained for the rest of your life. Only about 20% of retirees choose guaranteed annuities that provide a pension for as long as you, or if you choose, you or your spouse, live. These annuities can provide a level income, a fixed increase or inflation-linked annual increase, or an increase based on a share of the returns on the underlying investments called a with-profits annuity. The 2015 winner of the financial planner of the year award, Wouter Fourie of Ascor Independent Wealth Managers, told the FPI's recent Retirement and Investment Conference that "level, fixed-increase and inflation-linked annuities have traditionally not offered good value — they are too expensive for what you get". With-profit annuities offered better value, he said. "We need to challenge the life companies. I think they are making a killing out of these annuities," Fourie said, because in his view life companies paid too little income from the investment. If you chose to receive an escalating income from a guaranteed annuity, the income drawn from your capital could be lower than the yield you could earn from investing in a government bond, he said. Life assurers invest mostly in bonds to provide you with the income they pay you when you take out a guaranteed annuity. The income offered on guaranteed annuities should therefore increase or decrease in line with bond yields, but Craig Gradidge, an independent financial planner with Gradidge Mahura Investments, said guaranteed annuity rates did not appear to have increased despite increasing bond yields. Andrew Davison, the head of implemented consulting at Old Mutual Corporate Consultants, said it was not true that a bond could deliver a superior return. You would need a 35-year bond to ensure an income from age 65 to 100 - the age you need to plan for because people were now living for longer, he said. A guaranteed annuity can deliver a higher pension than the interest and capital repayments you could get from a 35-year bond because annuities pool investors' capital and the annuity payments are based on the average life expectancy of the group, which will be lower than 100. Davison said the pricing of guaranteed annuities should be more transparent, but retirees should not underestimate the benefit of the insurance such policies provided against the high risk of outliving one's savings. "We typically insure our cars and homes, but at retirement most of us choose to use a living annuity without any insurance against a key unknown factor — how long you are going to live," he said. Old Mutual tested the ability of a R1-million living annuity to sustain an initial income level of 6.5% of the capital, increasing by inflation each year. It tested 75 annuities with starting dates six months apart from January 1951. The annuities were invested in balanced portfolios of equities, bonds and cash and the average real (after inflation) return was 5.5% a year over the entire period. However, the sequence in which good and bad returns were earned, combined with the consistent income withdrawal, resulted in 42 of the 75 annuities failing to sustain the required income, Davison said. The shortest period over which an annuity supported the required income was just 13 years. Fourie said the best option was to use both a living and a guaranteed annuity, but annuity providers needed to do more to enable the combination to work for you. You should be able to initially split your capital between a living and guaranteed annuity and then to slowly migrate capital from the living annuity to the guaranteed annuity, he said. Life companies should be able to offer guarantees on living annuities, and the administration fees should not be charged as a percentage of the amount invested, Fourie said. Finally, you should be allowed to reduce your withdrawal from a living annuity to zero, he said — currently you must withdraw at least 2.5%. This would enable people to use a guaranteed annuity for their basic income needs and to withdraw from a living annuity only when investment markets favoured this, or when they needed to access funds, for example for medical expenses. If you would like to find out more information about Retirement Annuity, please contact Kevin or Thato, email: [email protected] tel no: (011 658-1333) Source: BD Live
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