Considering the risks of living annuities – outliving one's money, and ongoing uncertainty in the markets – is a living annuity an option, or should retirees seek safety in a guaranteed annuity?
But does it have to be one or the other? Perhaps by blending products, retirees could find the perfect retirement solution. We tested various scenarios, and concluded that securing essential income in a with-profit annuity and investing surplus assets in a living annuity could provide for better outcomes for both the annuitant and the adviser. To illustrate this point, we have created an example of a 50/50 split between a Just Retirement Enhanced With-Profit Annuity and a living annuity.
Eddie retires at 65 with R2m in his retirement fund. His spouse, Priscilla, is 62. They are both in good health and at least one of them should live for a further 25 years or more. They need R10,000 per month (R120,000 pa) to cover their essential bills for as long as they live. Let’s compare two options for Eddie and Priscilla.
Option 1: Invest 100% in a living annuity
- Invest the full R2m in a living annuity.
- Draw R120,000 pa and increase this each year with inflation.
- Invest in a moderate-risk portfolio to balance the need for short-term income with long-term growth.
- The adviser takes a fee of 0.5% pa.
Option 2: Invest 50% in a Just Retirement Enhanced With-Profit Annuity and 50% in a living annuity
- Invest R1m in a Just Retirement Enhanced With-Profit Annuity, which will pay R66,000 pa and will target increases in line with inflation, and
- Invest R1m in a living annuity, drawing R54,000 pa (to make up the R120,000 pa they require at the outset, increasing with inflation).
- The guarantees provided by the Just Retirement Enhanced With-Profit Annuity allow Eddie and Priscilla to invest their living annuity in a portfolio more strongly focused on long-term growth, targeting an additional 1% pa in investment return. (Typically asset managers suggest that 10% higher equity allocation is expected to generate an additional 1% pa return in the long term.)
- The adviser takes a fee of 1.5% upfront on the R1m invested in the Just Retirement Enhanced With-Profit Annuity and 0,7% pa on the amount in the living annuity. Because the living annuity is focused on long-term growth, there will be more active advice each year.
This is how the income and assets available in the living annuity escalate over time under the two options.
By the time Eddie and Priscilla reach their life expectancy:
- Option 2 is generating 35% higher income (R520,000 compared to R375,000).
- Option 2 has 40% more assets available for a rainy day or beneficiaries (R2,92m compared to R2,14m).
- Under Option 1, they face a cap of 17,5% drawdown rate on dwindling assets.
- The adviser has earned approximately the same remuneration under Option 1 and 2.
Option 2 performs better because:
- The additional 1% pa investment return generated by the higher proportion invested in growth assets helps the living annuity in Option 2 to grow significantly faster.
- The income from the Just Retirement Enhanced With-Profit Annuity is guaranteed no matter how long they survive and what happens to investment markets. This allows a lower drawdown rate from the living annuity in Option 2, and a sustainable income when they survive beyond their life expectancy.
Option 2 is also lower risk. In the event of a market crash, the Just Retirement Enhanced With-Profit Annuity smooths this over a six-year period. However, under Option 1, Eddie and Priscilla are required to increase their drawdown rate to receive the same amount of required income for the year, which means there are fewer assets available to benefit from any subsequent recovery in the investment markets.
The very realistic example of Eddie and Priscilla illustrates the circumstances of the majority of retirees purchasing living annuities. The methodology in the example can also be used to show that even clients with a drawdown rate of 5% who could shift 50% of their portfolio towards growth assets, would benefit from using a combination of a Just Retirement Enhanced With-Profit Annuity and a living annuity. The optimal split will depend on your needs analysis with your client.
Of course, if your client is one of the 40% of the population who qualifies for an enhancement due to ill health and lifestyle factors, they could do even better.
If you have any queries please email