Recent innovations around retirement products address the issue of how to leave a legacy while still guaranteeing your income in retirement.
People generally have two fears when it comes to retirement: firstly, whether they will have sufficient income in retirement, and secondly, what would happen to their retirement money should they die in early retirement. In the case of a life annuity, the income stops on their death (unless they had a joint annuity with their spouse) and their children receive no inheritance from the parent’s life savings.
For this reason living annuities have become popular products. A living annuity invests the lump sum in a market-related investment and the retiree may draw down anywhere from 2.5% to 17% of the capital each year. The investment has the opportunity to grow at above inflation as it is market-linked, and any capital that remains on the retiree’s death can be paid to their beneficiaries.
Unfortunately because so few people retire with sufficient capital, they are forced to draw down more than the recommended 5% – 6% per annum, which means that many retirees outlive their capital, leaving nothing for their children.
In comparison, a traditional life annuity pays a guaranteed monthly income for the rest of the retiree’s life and can be linked to inflation, so you are guaranteed to continue to receive an income, but it cannot be left to your children.
Nearly 80% of retirees are now opting for living annuities. Although this may reflect a desire to leave a legacy, the reality is that most retirees have not saved enough to purchase a sufficient guaranteed income and need to draw down aggressively on their capital in retirement, leaving them destitute in later years.
This has become so pervasive that National Treasury has raised concerns about the mis-selling of the product, resulting in the retirement industry returning to the drawing board to find new solutions that blend the positive aspects of a guaranteed income with those of market-linked investments. Over the next few years we should continue to see more innovation around retirement products.
Hybrid annuities
Glacier by Sanlam Investment-linked Lifetime Income Plan
This product is for investors who want to know their money will not run out but also want the benefit of a potentially higher income in retirement
This product blends the benefits of an income for life with the potential for above-inflation income by linking the annual income increases to underlying market returns. If there has been a strong market performance a retiree could see their annual income increase ahead of inflation – but like any investment, any upside comes with the risk of a downside.
If the underlying investment delivers a flat or negative return, a retiree could see their income dip, as costs still need to be deducted irrespective of returns. If, however, over time the market delivers above-inflation returns, the retiree would have a significant increase in their income over time. The risk would be for a market correction in the first or second year of the investment.
Like a traditional life annuity, the income dies with the retiree or the spouse and would not provide for leaving an inheritance – however given the current retirement statistics from the 2013 Old Mutual Retirement Survey which found that 45% of retirees expect to run out of money in retirement, leaving a legacy is not necessarily an option for most retirees.
For someone who wants to have some form of guaranteed income but leave a legacy
The Liberty Flexible Annuity aims to provide retirees with some protection against outliving their capital while also providing them with an option to leave some form of inheritance. While investing in an investment-linked living annuity a retiree can commit a percentage of their retirement savings to the “Income Enhancer Benefit”. The commitment by retirees who have passed away forms a bonus pool which can pay out bonuses each year. This bonus can be used to supplement the retiree’s income or can be added to the retirement investment for growth. On the retiree’s death the balance that remains in the investment-linked annuity which was not committed to the Income Enhancer Benefit is paid to their beneficiaries.
Old Mutual Living Annuity with Investment Top-up
For someone who wants the flexibility of a living annuity but also some protection against longevity
The Investment Top-up can be taken out in conjunction with a living annuity and provides a lump sum on survival to a certain age. You would use a portion of your living annuity investment (maximum of 8%) to purchase a single-premium guarantee to pay out a lump sum should you reach a certain age. The minimum age you can select is 75 and the oldest is 95. This allows for better financial planning as you can select a lump sum to kick in at the age of 80, for example. You would then be able to structure your living annuity to provide an income until that age. If you die before your selected age (80, in this example), no benefit is paid out.
Old Mutual also offers a life annuity with a death benefit (Capital Preservation) which pays out a lump sum on your death so that you are still able to leave your children an inheritance while guaranteeing your income. As this product does not require underwriting, it may be less expensive to take your own life cover if you are in good health.
Alexander Forbes Lifestage Annuity
This uses financial planning to combine a living annuity with a life annuity
According to Alexander Forbes, it is worthwhile considering the merits of a hybrid annuity which essentially allows you to initially invest in a living annuity and then convert to a life annuity several years after retirement. By initially investing in a living annuity you are able to allow your money to grow (as long as you do not draw down too much money) and annuity rates or “implied yield” you receive from a life annuity increases the later you invest.
The later you annuitise, the higher the yield (or income as a percentage of your lump-sum investment) as you are funding fewer years in retirement. So by delaying the purchase of a guaranteed annuity you are able to increase the amount you receive monthly.
Interest rates also affect the level of annuity you would receive. If interest rates are low – as has been the case – you would be locked into a low-interest annuity and miss out on future interest-rate increases. In a low-interest-rate environment it makes sense to delay the purchase of an annuity until interest rates are higher.
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