Wessels says generally retirees hope to achieve two goals when retiring from their retirement funds. The first is to have sufficient monthly income to be able to meet their needs in retirement. The second is to provide for a death benefit for beneficiaries.
She says while this sounds simple and straightforward, it is not. “Circumstances and financial needs differ from individual to individual and the choices made at and during retirement will determine whether a retirement income lasts for the rest of a person’s life or whether the capital is depleted and the pensioner has to then rely on the Government grant or family support or both.”
Wessels says research by actuaries John Anderson and Steven Empedocles explored the question of combining a life annuity with a living annuity.
The two actuaries made the important point that basing a retirement strategy on the expectation of a death benefit is a double edged sword as the death benefit is a positive feature only as long as there is capital remaining. However, the key risk with living annuities is running out of capital. Once this has happened, the death benefit turns negative. Instead of leaving a death benefit to beneficiaries pensioners become dependent on their families or the Government.
Wessels says the majority of retirees can better meet their financial goals in retirement by allocating all or some of their savings to a life annuity and allowing an insurer to manage the various risks associated with providing a sustainable lifetime income.
“Where retirees opt to use a portion of their retirement savings to buy a life annuity and invest the rest in a living annuity, the risk of depleting capital is managed. The retiree doesn’t have to draw down as much of their capital when markets have performed poorly, like we have seen over the last few years.”
She adds that the insurer would be managing the risks in the life annuity, and therefore the retiree does not have to be so conservative with the living annuity assets and is able to rather invest in more growth assets that are expected to provide a higher return. A life annuity can also be structured to suit individual circumstances by ensuring the benefit is paid for a minimum period even if you die (this adds a death benefit element to it) and by making sure that a portion of the annuity will continue to be paid to a surviving spouse or partner after your death.
Wessels points out that life annuities can be considered true insurance, while living annuities are a form of self-insurance. “You can self-insure if you have enough savings to do so. For example if you have a large amount of savings you don’t have to have car insurance as you can simply use those savings to replace your car in the event of something happening to your car.”
In the case of annuities, self-insurance means having enough capital to last as long as the pensioner lives, irrespective of how long that might be or what happens to investment markets. Unfortunately, says Wessels, the majority of pensioners do not have enough savings to self-insure the sustainability of their income for an uncertain lifespan.
She says rather than trying to compare and then choose between these two fundamentally different products, for some pensioners there is merit in considering a combination of the two annuity options.
“While retirees will still be able to use a financial adviser and opt for any of the products available on the broader market, retirement funds will from now on be required to provide quality, easy-to-access solutions supported by simple communication and guidance.”