Guaranteed pensions offering best rates in a decade

Question: If you retired tomorrow at age 65, with R1 million what pension could your money buy?

Answer:

Option 1: Around R7000 a month guaranteed for life and increasing each year with inflation.

Option 2: Around R7000 a month, growing with inflation, but most likely only until you are 74. After that it will decline in real (after-inflation) terms.

What do most South African retirees choose? Option 2 with the pension that can only keep up with inflation for less than a decade.

Why? The second option is what you would most likely get investing in an investment-linked living annuity from which you draw a pension from underlying investments. Most South Africans choose to invest their retirement savings in a living annuity, but they don’t realise that in choosing this product they should choose a lower income than a guaranteed annuity to ensure the income is secure for the rest of their life.  Read more: What kinds of annuities (pension) can I buy when I retire?

That is especially true right now, because guaranteed annuity rates are currently offering the best income levels in more than 10 years and an incredible opportunity for those retiring, Jeanine Astrup, a consulting actuary and member of the Actuarial Society of South Africa (ASSA) Retirement Matters Committee, says in a recent release from ASSA.

How the numbers stack up

Astrup calculated that if you are a man aged 65, R1 million will buy you a pension of R7117 a month guaranteed for the rest of your life and increasing at 6% a year. By the time you are 85, your pension will be worth R22 824. (Women typically receive a bit less because they typically live longer.)

If you were able to earn an annual return of 5% above inflation on your investments, you could start drawing the same amount from your R1 million invested in a living annuity and increase your income with inflation each year, but probably only until you are 74, Astrup says.

At that age you would reach the maximum withdrawal rate allowed from a living annuity – 17.5% of your savings – and your income would then decline in real (after-inflation) terms.

By the time you are 85, your income will be worth just R7 006 a month, Astrup says.

The fallacies about legacies

Most South Africans prefer living annuities because they offer the chance to leave any capital remaining to family when you die.

But the majority of South Africans do not have enough saved for retirement to allow them to draw low enough percentages as a pension to ensure their income is sustainable for their entire retirement and that they leave money to their family.

They end up relying on family to supplement their dwindling income. Read more: What are the risks when drawing retirement income from investments?

South Africans dislike guaranteed annuities because they believe the annuity stops when they die, leaving no legacy. It is, however, possible to leave an income legacy by adding a dependant to your annuity to ensure that person will continue receiving an income after you die – either for a guaranteed period or for life, Astrup says.

You need to understand that this option comes at a cost and will reduce the income you receive during your lifetime, she says.

Another option is to combine a guaranteed annuity with a living annuity for a higher starting pension without the risk of eroding your capital, Astrup says. Read more: Choosing a pension more about blending than choosing one over the other.

Retiring on R10 million

The benefits of a living annuity only really apply to the wealthy, to people with advanced financial skills, to people with expenses well below a sustainable living annuity income, or those with a short life expectancy due to illness. “It is a very sophisticated financial instrument with an enormous burden to manage,” she says.

If you were able to save R10 million by age 65 and, as a man, buy a guaranteed life annuity with a guarantee to pay for 10 years regardless of when you die, it will give you a monthly income of R64 448, which increases with expected inflation of 6% every year until you die, Astrup says.

By the time you reach age 85, your monthly pre-tax income will be R206 693, assuming inflation of 6% each year.

To achieve the same starting income with a living annuity, you need to draw from your savings at a rate of 7.73%. If the portfolio achieves annual investment growth of inflation plus 6.5%, your income will peak at R145 710 at age 79 and then decline, Astrup says.

At age 85, your income will be R98 468, less than half of what the guaranteed life annuity would be paying, she says.

Capital investment	Guaranteed life annuity  escalating annually with inflation of 6% (with a 10-year income guarantee)		Living annuity with the drawdown increasing annually with inflation until the 17.5% cap is reached (annual growth of inflation plus 6.5% & 1% upfront commission, 1% ongoing fees (incl VAT)
	Starting income at 65 (before tax)	Income at 85 (before tax)	Starting income at 65 (before tax)	Income at 85 (before tax)	Age at which income starts declining
R1 million	R7 117	R22 824	R7 117	R7 006	74
R10 million	R64 448	R206 693	R64 448	R98 468	79

Source: Jeanine Astrup, Actuarial Society of South Africa

Too many retirees drawing too much

AlexForbes recently analysed the rates at which its living annuity pensioners are drawing from their savings. It found that a large proportion has drawdown rates higher than what is considered “sustainable” by the Financial Sector Conduct Authority that has published a proposed conduct standard for living annuities offered as default pension options by retirement funds, John Anderson, executive for Solutions and Enablement at AlexForbes, says.

Annuity provider JustSA looked at a sample of financial advisers’ retired clients. This showed two-thirds were drawing an income at rates higher than what is regarded as safe for their age, Deane Moore, CEO of JustSA, says. Check how sustainable your income will be with our Living annuity calculator.

Both Anderson and Moore found at least half of those pensioners with unsustainable drawdown rates could achieve sustainable rates by converting their living annuities (or at least basic monthly expenses) to a guaranteed annuity to take advantage of the attractive rates.

Anderson says AlexForbes has seen an increase in the take-up of all types of guaranteed annuities, but particularly in those with fixed annual increases of 5% or 6% and those in hybrid annuities.

Moore says the reason that life annuities sustain a higher income for life, is that policyholders pool their risk and those who die earlier cross-subsidise those that live longer.

Continuing to draw a high percentage of capital, however, puts these retirees at risk of their income reducing over time – a risk that could be exacerbated by a market correction, he says.

Why are guaranteed annuity rates so high now?

Annuity rates move in line with interest rates. When interest rates are high, annuity rates are attractive. When interest rates are low, annuities are more expensive, Anderson says.

Interest rates are used to discount the monthly annuity payments the life insurer expects to make to you over your lifetime and higher rates mean it’s cheaper for the life company, he says. 

At the moment, interest rates are high. Real (after-inflation) yields on inflation-linked bonds with longer terms to maturity are in excess of 4.5% a year.  Ten years ago, these bond yields were below 2% a year, Anderson says.

This means that the price of buying a guaranteed inflation-related annuity is a lot more attractive than it has been over the last 10 years.

Bond yields are high because investors regard South African assets as risky and foreigners have been selling bonds, Anderson says. 

Moore says this may be the last opportunity for retirees whose income is at risk to secure their income with a guaranteed annuity, as the inflation rate has fallen over the past two months, and this could start to bring interest rates down.