By Vaughan Harries 22 hours ago Share this article: ShareTweetShareShareShareEmailShare You have worked in the last 40 years of your life only to reach retirement at a time when markets have fallen more than 20% since the beginning of the year. Those who now need to receive income from their retirement savings are sitting with the dilemma of which type of annuity (a financial product that gives you retired income) to choose from and how to navigate through these unprecedented times.
At the time of retirement, according to the rules of the Pension Fund and the Pension Fund, it is allowed to withdraw up to one third in cash (subject to tax) and allocate the remainder of the savings for the pension to provide an income. Currently, a retirement fund allows you to access it entirely in cash (taxable) at the time of retirement. The amount that goes to the annuity is transferred, tax free. Keep in mind that any income received from the annuity once set is subject to income tax.
There are two main types of annuities:
1. A life annuity
Also known as a guaranteed annuity, this is an insurance type product that will pay you a predetermined income until you die. There are various types of annuity options, but they mainly differ in how income increases each year.
The most common types of annuities are:
Fixed: choose a predetermined annual increase, e.g. 0%, 3%, 5% or 10%. The higher the annual increase you choose, the lower the initial income you will receive.
Inflation-linked: increases are based on the inflation rate during the year. Generally limited to a certain level.
With profit: the insurer declares annual increases generally related to the investment performance of an underlying portfolio in the product. Other factors may also be considered.
There is certainly no "one size fits all" with regards to life annuities since each type has its advantages and disadvantages.
In order to ensure that the spouse and / or dependents are expected, you can choose the income to be paid to the spouse for their life if you die before them or include a "guaranteed period". The warranty period means that if you and your spouse pass prematurely (before the end of the warranty period) your earnings will pay for the rest of the warranty period to anyone you choose (usually an employee).
Life insurers' annuity quotes usually change on a weekly basis. It should be noted that the purchase of a life annuity and the type of life annuity is definitive and fixed for life. It is not possible to invert or change the selection once purchased.
2. A living income
This is an investment product in which you choose the amount of income you take. You can adjust the amount you take every 12 months and it must be between 2.5% and 17.5% of the value of the life annuity. The most important thing to remember with a life annuity is not to gain too much income over time as this means that you will be out of money before you die.
In the event of death, the money remaining in the living year will go to your dependent family members and beneficiaries. Try to avoid falling into the trap of selecting a living annuity with the intention of leaving money for your family, as the main purpose of pension funds should be to provide you with an income for life.
In a life annuity you run the risk of being able to live longer than expected and ultimately run out of money. This is where the decision between choosing a life annuity becomes very important and needs to be discussed with your financial advisor.
You can always convert your full life annuity into a life annuity at any time, however the reverse is not possible.
What to do?
Local and global markets have declined sharply as fears of a global recession caused by COVID-19 continue to rise. Unless your pension fund has been placed into a money market fund (i.e. 100% cash), you will have experienced a variable drop in the value of pension savings depending on your exposure to the equity markets.
The only thing that the previous important market crashes like the global financial crisis in 2008, Dot-com Bubble in 2000 and Black Monday in 1987 had in common is that all three had major recoveries in the three years following the crisis .
The advice you will receive, during extreme market volatility, is to stay invested and avoid making "knee jerky" changes as this can have a lasting impact on the value of your investment. Ignoring this advice and making irrational decisions in times of panic can eventually lead you to block recent losses at the bottom of the market when recovery is likely to occur in the future.
Buying a life annuity at a time when markets have declined significantly could permanently block lower initial income due to the fact that the value of retirement savings is now lower. However, due to current conditions in the South African market, government bond yields have increased (these have a large effect on income from life annuities), which means that life insurers offer higher initial returns on life annuities than recent past. This would then help give you an income comparable to before the market drop.
Taking this into account, annuities could be viewed as an attractive option in volatile markets as there is no need to worry about market performance and the durability of the bear market. This tranquility could arouse the interest of retirees who are currently retiring at unsustainable levels from their life annuity, as you may receive similar but sustainable income from a life annuity.
As an annuity investor, you could adopt an investment strategy in which to divide the portions of the annuity into "buckets" to each bucket assigned a target, a time frame and an adequate asset allocation. This structure can be used as a tool to help investors stick to the principles of not "selling" growth when markets have fallen to finance income.
That said, the best defense for a life annuity during a bear market is to try to reduce your withdrawal income or at least keep it the same on the next anniversary date.
With the above in mind, it is important to consult your financial advisor during these uncertain times to manage retirement savings in a way that will give you the best opportunity to have sustainable income in the future based on your unique circumstances.
Vaughan Harries, certified financial planner with Alexander Forbes.