With growth and inflation pressures, what are your thoughts on guaranteed pension funds vs a living annuity? My thoughts are that with a living annuity, the fund needs to perform at a minimum of 12%-13% before inflation to sustain 30 years with a maximum drawdown of 4%-5%, and this is very conservative. Is there a website that reports guaranteed annuity rates?
— Benji P
Answer:
The reader asks two important questions. First, the low-growth, high-inflation environment we find ourselves in certainly points to a higher allocation to guaranteed annuities, especially those with built-in inflation protection. These annuities increase by the official inflation rate, so pensioners will earn a higher income as a result. The low-growth environment points to lower expected returns from assets such as equities and property. Over time, however, equities tend to offer a return above inflation. There’s usually an adjustment period as we move from a low-inflation to a high-inflation environment, but equities typically deliver an annual return of inflation plus 6%-7%.
The choice between a guaranteed annuity and a living annuity typically comes down to the requirements and circ*mstances of the individual investor, rather than expected market returns. Both are post-retirement income products which offer different propositions. Guaranteed annuities offer a guaranteed income stream for the retiree’s life, irrespective of how long they live. Living annuities pay an annuity based on the fund value and the retiree’s chosen income drawdown rate. An annuitant can draw down between 2.5% and 17.5% of capital as an income. They take on market risk and may very well run out of capital (and therefore income) before the end of their life.
The choice comes down to the retiree’s preference for either income security or leaving a legacy. With retirement money, investors often have to choose one or the other.
In the past two decades there has been a significant move to living annuities, and by the end of 201690% of flows went in that direction. It appears this trend is reversing, with an estimated 20%-30% of flows in 2020 going to guaranteed annuities. This makes sense, since guaranteed rates have finally started trending higher, market returns have been low since September 2014, and retirees are living longer.
To address the reader’s comment that a living annuity needs to earn a minimum of 12%-13% to sustain 30 years of income drawdown, he is correct. Two variables affect income sustainability: drawdown rate and portfolio return. The table assumes income is increased at 6% a year. Only six of the 35 combinations shown result in income lasting more than 30 years.
When the reader is ready to start taking income, he should obtain quotes from several insurers as income rates can differ by as much as 20% at times. He also needs to choose the correct guaranteed annuity, considering issues such as guaranteed term, spouse benefit and increasing annuity. There is also the option of a new-generation hybrid annuity, combining living and guaranteed annuities in one product.
Visit www.masthead.co.za/annuity-investment-rates/ for annuity rates of various insurers and products.
— Craig Gradidge, investment and retirement planning specialist: Gradidge Mahura
Send your questions to yourmoney@fm.co.za
It's fascinating to delve into the realm of retirement planning, especially considering the complexities of pension funds and annuities. Now, when discussing guaranteed pension funds versus living annuities, a nuanced understanding emerges from the intricate interplay of various factors, such as market conditions, individual preferences, and financial goals.
Let's start with the context of low growth and high inflation, as this significantly impacts the choice between these two financial instruments. In such an environment, leaning toward guaranteed annuities seems prudent, particularly those equipped with inflation protection mechanisms. These annuities escalate in line with the official inflation rate, ensuring pensioners receive a higher income over time to cope with rising living costs.
The argument about low growth affecting expected returns from assets like equities and property is valid. While these assets might initially offer lower returns, historically, equities tend to outperform inflation over the long term, averaging around inflation plus 6%-7% annually. However, transitioning from a low-inflation to a high-inflation scenario might involve an adjustment period.
Choosing between guaranteed annuities and living annuities isn't solely dependent on market forecasts; it pivots on an individual investor's circ*mstances and needs. Guaranteed annuities promise a steady income stream throughout the retiree's life, irrespective of lifespan. Conversely, living annuities base income on the fund value and chosen drawdown rate, exposing the annuitant to market risks and the potential to deplete their capital prematurely.
The trade-off often boils down to preferring income security or leaving behind a legacy. Balancing these factors becomes crucial, especially considering the significant shift witnessed in retirement investment preferences. Over the past two decades, a predominant movement towards living annuities occurred, but recent trends suggest a reversal, with 20%-30% of investments in 2020 directed towards guaranteed annuities due to rising guaranteed rates, prolonged low market returns since 2014, and increased life expectancy among retirees.
Addressing the reader's concern about sustaining a living annuity over 30 years with a 12%-13% return requirement, it's accurate. Sustainability hinges on the drawdown rate and portfolio return. The sustainability table presented highlights that only specific combinations allow income to last beyond three decades, emphasizing the delicate balance required in such financial planning.
For those seeking further information on annuity rates, visiting websites like www.masthead.co.za/annuity-investment-rates/ offers insights into rates across different insurers and products. This facilitates informed decision-making regarding annuity selection, considering factors like guaranteed terms, spouse benefits, increasing annuities, and even exploring hybrid options amalgamating living and guaranteed annuities into one product.
Craig Gradidge's expertise, as an investment and retirement planning specialist, provides invaluable insights into navigating the complex landscape of retirement investments. The nuances presented in his response aptly capture the intricate dynamics at play when contemplating guaranteed pension funds versus living annuities in a changing economic landscape.
