This article is brought to you by Brenthurst Wealth*
By Sonia du Plessis*
As retirement approaches, many people are caught between the thrill of seeing out their golden years and the fear of having saved enough. Itâs perfectly natural when entering this new phase of your life to feel a little unsure about the future, but it doesnât have to be a time marked by constant financial stress.
With a little planning, you can get a decent picture of how much you have and how long that will last. Once you have this picture, itâs decision time. A decision that I believe is one of the biggest retirement choices you can make: whether to choose a living annuity or a life annuity.
Letâs compare these options directly, to help you make an informed decision.
Guaranteed income vs investment risk
A life annuity offers a guaranteed monthly income for the rest of your life. This means you know exactly how much money you will receive each month, providing a sense of security and stability. By contrast, a living annuity is a market-linked investment.
The âgolden ruleâ about a living annuity is to take an income not more than 4%- sometimes can be pushed to 5%. If a retiree can stay within this income percentage guideline, a living annuity would be the preferred choice. With a living annuity, you choose how much to withdraw each year â between 2.5% and 17% to your capital â and you can adjust this every year to suit your needs and in response to market performance. This offers flexibility but comes with own set of risks. In the event where markets perform poorly and where a higher (than recommended) income is drawn, a retiree will have the risk of running out of capital very quickly.
Which is right for you?
A life annuity is preferred mostly by retirees who arenât confident that their savings will outlive them. Other instances where it makes sense is if you have a fixed, predictable income stream to fund your lifestyle, or you donât have a spouse or dependents to inherit your estate.
Life annuities are sold by insurance companies that invest your savings, and in return they pay you an agreed income for as long as you live. If you live longer than expected, the insurer will suffer a loss, but also, if you live shorter than expected, they will make a profit.
On the other hand, a living annuity is best suited to retirees who have sufficient retirement savings. This option is appealing if you understand that your future income is tied to the performance of financial markets, and if you want the flexibility to adjust your withdrawal rates.
Predictability vs flexibility
Life annuities are more predictable. Once you invest, your income is fixed, and you donât have to worry about managing your investments. This can be especially comforting during times of economic uncertainty.
On the other hand, living annuities offer flexibility. You can adjust your withdrawal rate every year based on your needs and market conditions, giving you more control over your monthly income.
Capital access and inheritance
With a life annuity, your money is locked up once you invest. You cannot access the capital, and unless you choose to receive income for a guaranteed period, no funds will be left for your estate.
By contrast, living annuities allow you to keep your capital invested. This means you can leave any remaining funds to your heirs, providing a legacy for your family.
Inflation protection
Life annuities come in different types, including inflation-linked annuities that adjust your income in line with inflation.
Living annuities do not have built-in inflation protection, however if your withdrawal rate is 5% or lower, and your portfolio is invested in a well-managed portfolio of funds- it will be highly likely that you will be able to take an annual increase on your income.
Managing longevity risk
A significant advantage of life annuities is that they eliminate the risk that youâll outlive your savings. No matter how long you live, you will continue to receive your guaranteed income. This can be especially important as people are living longer.
With living annuities, you bear the longevity risk, however if you stay within the golden withdrawal rate of not taking more than 4%-5% to capital, your capital should be able to last you your lifetime. The BIG problem however comes in when you start with higher withdrawal rates. A withdrawal rate of 7% and higher is dangerous territory.
Interest rates and market conditions
Life annuities are more attractive when interest rates are high, because they generally offer better income rates. On the other hand, if interest rates are low, the income from a life annuity will not be as appealing.
Living annuities are influenced more by financial market conditions. This means your returns will be higher if markets perform well but could also be lower if the markets do poorly.
Combining both for a balanced approach
An option that I often suggest to clients is to take a balanced approach in which you combine both types of annuities.
Hybrid annuities include a guaranteed portion within a living annuity, offering a mix of stability and flexibility. Alternatively, you can use different pension sources to fund each type of annuity, providing a stable income while allowing other investments to grow.
For example, consider a male retiree (letâs say John) with R1.7 million, John is 76yrs. With a life annuity, he can expect to receive a guaranteed income of R13,300 per month, with inflationary increases and a ten-year guarantee. This provides a steady and predictable income that adjusts for inflation, maintaining purchasing power. This is under current high interest rates we are enjoying. When interest rates go down, John will be quoted a much lower income.
By contrast, if the same amount is in a living annuity and John withdrew 5%, he would receive R7,085 per month. While this is lower, the flexibility to adjust the withdrawal rate and the potential for investment growth appeals to John â who is comfortable with financial risk and who wish es to leave a legacy to his only child.
Choosing the right annuity depends on your financial situation, risk tolerance, and retirement goals. I strongly recommend that you consult with a financial adviser to help you tailor a strategy that ensures a comfortable and secure retirement, blending predictability with flexibility to suit your unique needs.
*Sonia du Plessis, CFPÂź, is Head of Brenthurst Wealth Stellenbosch [email protected]
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