The Benefits of Blending
Answering the life versus living annuity debate
The danger of increasing your drawdown rate in a living annuity is widely publicised. Practically, an increase of just one percent, say from 6,5% to 7,5%, could see the ability to have a sustainable income for life decrease significantly. Retirees could reach the ‘point of ruin’ two to three years earlier than expected. This is the point at which a retiree reaches the maximum drawdown rate and has to start drawing down less, in rand terms, every year.
There are options that enable a higher sustainable drawdown with less associated risk. When comparing current market solutions, retirement income specialist Just SA shows how pensioners could increase their monthly income by 25% by purchasing a new-generation with-profit life annuity, rather than a traditional living annuity. In return for this higher lifetime income, they would need to forego the flexibility of how much they can draw.
If they value the flexibility that comes with a living annuity but want to access a higher monthly income with higher certainty, they might consider a hybrid or blended annuity that offers a combination of a living annuity and a lifetime income. This hybrid arrangement is more favourable than either solution on its own.
“By purchasing a blended annuity, pensioners can choose where they want to position themselves on the risk spectrum between needs and wants, as blended solutions allow them to decide how much of their living annuity portfolio should be allocated to the guaranteed component, and how much should be invested in the market,” says Just SA CEO, Deane Moore. “This gives them full discretion to increase long-term capital growth to meet flexible financial needs or to leave a legacy to beneficiaries”.
A practical example
A financially-astute couple, 65 year old male and 61 year old female, have R6 million in retirement savings. They calculate a retirement income requirement of R20,000 per month, being around 65% of their final pre-retirement household salary, in order to live comfortably in their golden years. This equates to a drawdown rate of 4% per annum, the industry ‘rule of thumb’ for a sustainable drawdown rate in a living annuity.
This couple could secure a with-profit life annuity providing R25,000 per month, a rate of 5% in normal market conditions, that is guaranteed for life, with 100% of income payable while either one is alive. The monthly income never decreases and offers good protection against inflation.
A blended annuity allows them to allocate a portion of their funds to a lifetime income portfolio within the living annuity investment vehicle, which operates the same as a with-profit annuity. If the couple allocate 50% to the lifetime income portfolio, they can secure an income of R22,500, with R12,500 of this sum provided by the lifetime income portfolio.
To meet their retirement income requirement of R20 000, they only need R7,500, or 3% of the residual living annuity assets, which is lower than the recommended sustainable drawdown rate in a traditional living annuity. In this way, the couple has retained some flexibility; improved the sustainability of their retirement income; and mitigated both longevity and investment risk.
Grappling with the annuity debate
At retirement, investors must grapple with choosing which annuity is best, even if annuity options are pre-selected by the trustees of their respective retirement funds. Once their choice is made, current regulations do not allow living annuities to be split after retirement. There is, however, the option to transfer a living annuity to a provider who offers a blended annuity with a lifetime income portfolio.
A blended annuity may serve as a good choice for pensioners looking to balance a guaranteed sustainable income with flexibility. It is also not an all-or-nothing decision, as it is possible to increase the allocation to the lifetime income portfolio at a later stage without splitting the annuity, in line with regulations.