By: Nashalin Portrag, Head of FundsAtWork at Momentum Corporate
Planning for retirement has one simple goal and that is to save enough money during working years to ensure that you can maintain the lifestyle you are accustomed to when you retire. Most members belonging to group retirement schemes average retirement age in South Africa is 60 and according to a study done by Lancet, by 2040 the average South African can expect an increased lifespan from approximately 62 years to 69 years. If health trends continue, that age could increase by as much as 12 years.
When these members retire, choosing an appropriate annuity product can be overwhelming. As a financial adviser you are best equipped to help guide your clients’ employees through this process and to help them achieve their financial goals. It is important to balance the risk and reward tradeoffs of the various risks that they may face.
There are three big “what if” risks that people face in retirement:
- What if the investments lose money, – known as Investment Risk: the risk that their income in retirement is impacted by the performance or lack thereof of the investment markets;
- What if inflation spikes – Inflation Risk: the risk that their income does not keep pace with inflation; and
- What if they live too long – Longevity Risk: the risk that they live longer than expected and their retirement income is not able to provide them with a sustainable income for the remainder of their life.
There are various annuity products to meet members’ retirement planning requirements. These annuity products generally fall in two broad categories:
- With a living annuity, members decide how they want to invest their money.
- Members must take an income of between 2,5% and 17,5% of their investment value every year. They can change the level of income each year, so it is flexible and can adjust as their needs change.
- Members’ beneficiaries will inherit what is left of their money after they pass away.
- Members’ money is exposed to the ups and downs of investment markets.
- Members take the risk of how long their accumulated savings will last and it is possible that they outlive their retirement savings.
- Members can decide to change a living annuity to a life annuity at a later stage.
Guaranteed annuity or life annuity
- A life (or guaranteed) annuity pays an income for as long as members live.
- The income will be calculated at the time that they buy the annuity. They can choose to have an income that remains the same for life or for it to increase every year at a fixed percentage, through annual bonuses (with-profit annuity) or in line with inflation.
- Usually, an increasing annuity will start at a lower level than an annuity that does not increase.
- After the member passes away, there won’t be any capital amount for their beneficiaries unless they choose a joint life pension or a guarantee term.
- Members don’t take any risk of investment markets performing poorly – their income is guaranteed for life.
- Members cannot make any changes after the income starts.
- Members cannot change their annuity to a living annuity at a later stage.
How could longevity influence the type of annuity that members choose at retirement?
There isn’t one type of annuity product that protects members completely from all the risks that they face in retirement. There could be some benefit in using a combined strategy of investing in multiple annuity types to give them the best of both worlds.
However, if the main concern is around eliminating their longevity and investment risk, a life annuity can be considered for a relatively bigger portion of their retirement plan since it provides them with a guaranteed minimum level of income for the rest of their life, even if they live to well over 100 years.
In particular, a with-profit annuity, a specific type life annuity, has the key advantages of creating a good tradeoff between the risks. It allows for minimum investment, longevity and inflation risk protection for retirees while still balancing the need to provide an adequate starting income and providing benefits to beneficiaries.
Financial advisers specialising in employee benefits are often challenged with not being able to provide individual advice to all their clients’ employees due to the large number of members they service. Also keeping in mind members’ lack of understanding of their benefits, financial advisers should consider partnering with a progressive retirement fund that considers the fund’s membership profile when crafting their default annuity strategy. Such a progressive retirement fund will also offer a multi-channel benefit counselling service to effectively partner with financial advisers to educate members on their benefits and to help them make the right annuity choice on the their journey to success.