If you are a member of a pension fund or have a retirement annuity, two-thirds of your final retirement amount must be used to purchase a retirement income.
You can select between a guaranteed life annuity or a living annuity. What is important to know is that once you have purchased an annuity you cannot “undo” it and get your capital back.
In this episode we just focus on a guaranteed annuity where you purchase a set income for the rest of your life. This is not like a bank account where there is a balance that earns an income. With a guaranteed annuity you hand over a lump sum in exchange for the guarantee that you will receive an income for the rest of your life.
The income continues for as long as you live but stops when you die. As with any insurance this is a cross-subsidisation – in this case between someone who passes away earlier than expected and someone who lives well beyond the average life span.
If you have had health issues prior to retirement, it is worth asking for underwriting. This is where the insurer takes your health status into consideration. If your estimated longevity is lower than the average, you may qualify for a higher annuity income.
Factors that are considered include if you earned lower income over your lifetime, you might have had less access to health care and nutritional food. Or had a lifestyle that exposed you to health risks, such as underground work, smoking, drinking or obesity. Or you may you have a life-shortening illness. Underwriting is optional and will never reduce your income.
Most guaranteed life annuities include a guarantee period where the income continues to be paid to your beneficiaries, even if you pass away. This is usually for five years after retirement. Your spouse could also continue to receive a percentage of the annuity income should you pass away. These all affect the cost of the annuity, or put another way, the amount of income you receive.
You should always opt for an annuity that increases in line with inflation, otherwise your income will not keep up with your expenses. This will mean less income initially, but rather supplement your income with ad-hoc work in your younger retirement years than having too little to survive when you are older.
Ask the right questions and understand what you are buying.