Many soon-to-be retirees are understandably worried. Their retirement plans may be in disarray as they face a serious decrease in the value of their retirement savings, driven by a sharp decline in investment markets due to the impact of the COVID-19 pandemic on the global economy, the oil price shocks and a downgrade to South Africa’s sovereign credit rating.
However all is not lost, according to Poobalan Govender, Manager of Income Solutions at Momentum Corporate. Somewhat of an unsung hero and underutilised retirement product option, with-profit annuities, could be the answer for many soon-to-be retirees in these uncertain times.
Govender explains, “A with-profit annuity will pay your clients a guaranteed monthly income for life. The guarantee includes the initial monthly income as well as any future increases, which are linked to the investment returns achieved in the underlying portfolio. The monthly income ends when the client passes away, unless they opt for their spouse to receive this income after their death or to have the income paid for the remainder of the guarantee period after their death if they selected a guarantee period.
Despite the current sharp declines experienced in investment markets, those who bought with-profit annuities are sleeping easy knowing that their annuity will not reduce, thanks to the guaranteed income for life.”
Govender says that there is a high probability that many members of retirement funds who are invested in typical market-linked balanced funds experienced a decrease of around 15% in the investment value of their retirement fund savings between December 2019 and March 2020. If your clients are one of these members, the good news is that this plunge has not decreased the value they will receive for their retirement savings if they buy a dynamically priced with-profit annuity. Govender demonstrates this by way of an example which compares the value they can expect from a with-profit annuity under market conditions in December 2019 and March 2020.
Let’s consider a male with retirement savings of R1 million in December 2019. He needs an initial monthly retirement income of R6 000, which then grows in line with inflation each year. He could have received a quote for a with-profit annuity that would ensure that he receives a starting income of R6 000 guaranteed for the rest of his life, plus pension increases that target inflation over the long-term.
Came March 2020, the same male finds he is no longer a millionaire since it is likely that his fund value has dropped due to the market decline, from R1 million to R850 000 (which is a 15% reduction in line with the earlier comment around market returns). Given that his capital reduced by 15% he might be expecting that if he purchased the with-profit annuity now, his income would also reduce to round R5 100 per month.
However, it’s likely that a dynamically priced with-profit annuity that reflects the latest market conditions would still provide him with a starting monthly income of around R6 000 per month, guaranteed for the rest of his life. This is because the cost of the annuity became cheaper in March 2020 with the increase in longer-term interest rates and lower investment markets returns. It is important to ensure that your clients are in the correct risk profiled portfolio as they approach retirement, which is what the life stage approach looks to achieve. In many cases, despite the sharp fall in fund assets seen in 2020, they can in fact purchase higher or similar annuity incomes now compared to what they could at the start of the year.
These currently favourable market conditions for with-profit annuity pricing mean that the R850 000 in March 2020 may be able to buy a similar with-profit annuity starting income that R1 million could have purchased in December 2019.
“It is however important to note that the pension increases they can expect in the short-term are likely to be lower now than those they could have expected in December 2019. This is in line with the lower investment market returns that currently prevail. Although high long-term interest rates were also seen in the 2008/2009 market declines, this may not always be the case. Also, even though long-term interest rates have reduced in April 2020, they are still higher than those in December 2019,” says Govender.
Govender concludes, “Good news is a rare commodity these days. The level of the guaranteed income available from a with-profit annuity under current market conditions may offer worried soon to-be retirees better news than they were expecting within the current uncertain investment market environment. In today’s volatile investment markets, it could be wise to invest at least some of their retirement savings in a with-profit annuity. However, this is one of the biggest financial decisions your clients will ever make so it is important that you, as their financial adviser, talk to them when they are making their choices to ensure that they consider all their options.”