Deciding how to invest your retirement fund when you retire can be a daunting decision, but you can approach it with confidence if you know the basics of the available options.
In South Africa, when you retire from a retirement fund such as a pension, provident, preservation fund or retirement annuity, you can invest all or part of your money in:
- a compulsory life annuity.
- a living annuity or
- a capital protector
In this article we’ll cover how a compulsory life annuity works – keep an eye open for the next few articles which will explain each option and compare all three.
A life annuity aims to solve the problem of outliving your money – so it offers a guaranteed income for life.
A life annuity is not strictly speaking an investment product – it’s closer to an insurance product or a life-right to income. You might say it’s the opposite of life insurance. Life insurance requires regular small payments while you are alive and pays a large lump sum if you die “too young”. A life annuity is funded by a large lump sum and pays regular income for life, protecting you if you “live too long”.
Here’s how it works:
The income you get from your life annuity depends on the following:
- How much you have available to invest.
- Your age (How long you are expected to live).
- The growth the product provider expects to get on the money you buy the annuity with.
In its simplest form a life annuity pays you a non-escalating income for life and when you die no further payments of income, nor any lump sums are paid to anyone. It just ends.
This solution may not address some of the big issues that are important to most retirees, so there are a range of tweaks you can make to your life annuity customize it for your personal circumstances. Let’s look at these.
Inflation
If your income does not escalate, then you effectively have less money every year as inflation drives up the cost-of-living. You can choose to have an escalating income instead of a level income on your life annuity and the escalations can be a fixed percentage, matched with inflation or even at a fixed percentage above inflation.
If you add an escalation, your income starts lower than if you choose a level income and the higher the required annual increase, the lower the starting income is for a given investment amount.
What about your spouse when you die? – Joint annuities
Many retirees want to make sure that after they die, their spouse or other dependent continues to receive an income.
You can add your spouse or another person as a “joint annuitant” on your life annuity. This means that your income will continue to pay until both annuitants have died.
The amount of income you get on a joint annuity depends on the expected lifespan of the younger person.
An interesting fact about annuities is that if a woman and a man of the same age retire and buy a life annuity for the same amount of money, the woman gets a lower income because women tend to live longer than men. Because of this and the fact that men often marry younger women, when a man adds a woman as a joint annuitant, there may be a significant impact on the income compared to the single annuitant option.
Improve the income on a joint annuity with an income reduction at first death
Another feature of life annuities, which can help improve the starting income on a joint annuity is the ability to instruct that the income reduces at the death of one of the annuitants. Since one person probably needs less income than two people do, this makes sense to consider. You can reduce the income by any amount up to fifty percent when one annuitant dies – and you can even have different reductions linked to each person.
The guarantee term
For many people, the idea that if they were to die soon after investing in a life annuity, their capital would be ‘lost”, is disturbing. This issue can be addressed by adding a guarantee term to the investment. A guarantee term is a minimum period of time for which income will be paid, even if the annuitant(s) die.
If the annuitant(s) dies within the guarantee period, the income that would have been paid over the balance of the guarantee period is paid to beneficiaries or the estate as a lump sum.
For example, if the guarantee-term is 10 years and the annuitant dies after five years, the income that would have been paid over the remaining five years of the guarantee term would paid to the beneficiaries as a lump sum. You can select a guarantee-term of up to 25 years. Adding a guarantee-term reduces the income you get; the longer the guarantee-term, the bigger the reduction in income.
You can customize your life annuity using a combination of these features to make sure your family’s needs are met. Once you set up the life annuity, no changes can be made to the terms, so it’s important to consider your needs before committing.
It is useful to know that if you invest in a living annuity, you are allowed to transfer the funds in the living annuity, in part or whole, to a life annuity in future, but you can’t move away from a life annuity.
In closing, some pitfalls to keep an eye out for. Be sure you understand the business rules around the timing of receiving investments, whether quoted incomes might change during the implementation of the investment, the impact of having your income in advance or arrears on the amount and timing of income, especially in the first month and monthly payment dates. Every insurance company has its own way of working and getting a different income to what you expect, at the wrong day or missing an income in the first month of moving between investments because of transfer dates can be inconvenient.
My mission is to help you retire confident – I hope that you have found this information informative and that it will help you engage better with your financial advisor and product providers. Please note that this article is not intended as advice – please consult a professional advisor before making any investment decisions.
I’d love to hear any questions or comments you may have, so please go ahead and mail me at mark@markcloetecfp.co.za
Remember – having a financial product is not the same a s having a financial plan.
Warm regards,
Warm regards,
PS. If you have any questions or comments, I’d really love to hear from you at Mark@markcloetecfp.co.za