In liv­ing an­nu­ities, high costs can out­weigh ben­e­fit of flex­i­bil­ity

Sunday Times - - Money - By PA­TRI­CIA HOLBURN

● In­vest­ment-linked liv­ing an­nu­ities are pop­u­lar among re­tirees, who in­vested R58.5bn in th­ese pen­sion plans for the year to June last year.

In com­par­i­son, a pal­try R5.8bn was in­vested in con­ven­tional an­nu­ities that guar­an­tee a pen­sion for life, ac­cord­ing to the As­so­ci­a­tion for Sav­ings & In­vest­ments.

But are liv­ing an­nu­ities a good choice? If you in­tend to op­ti­mise your in­come in re­tire­ment, liv­ing an­nu­ities are sel­dom a good choice, War­ren Matthy­sen, prin­ci­pal con­sul­tant at Alexan­der Forbes In­vest­ments, told the Ac­tu­ar­ial Con­ven­tion of SA held in Sand­ton re­cently.

He says when you use in­vest­ments in a liv­ing an­nu­ity to pro­vide your pen­sion, you get a choice of where to in­vest and how much to with­draw.

And you get own­er­ship of the in­vest­ment as, when you die, any re­main­ing cap­i­tal is paid to your ben­e­fi­cia­ries.

Con­ven­tional guar­an­teed an­nu­ities don’t of­fer the same con­trol or own­er­ship — you buy an in­come for life that may in­crease ev­ery year de­pend­ing on your op­tion.

When you die there is typ­i­cally no ben­e­fit for your ben­e­fi­cia­ries, although you can choose a pen­sion that pro­vides your sur­viv­ing spouse with a per­cent­age of the in­come.

Matthy­sen says con­ven­tional an­nu­ities are not easy to un­der­stand be­cause “peo­ple see the money go­ing into one pot, and when they die the money dis­ap­pears. So there is no con­cept of I’ve got this money and I’m in con­trol.”

He says this ad­van­tage that liv­ing an­nu­ities have over con­ven­tional an­nu­ities masks the com­plex­ity of the ben­e­fits and the po­ten­tially high costs.

Deane Moore, CEO of Just SA and a del­e­gate at the con­fer­ence, agreed that the mes­sag­ing around liv­ing an­nu­ities is sim­ple and there is a lot to gain from un­pack­ing the flex­i­bil­ity of liv­ing an­nu­ities when it comes to in­come and death ben­e­fits.

Matthy­sen says that in ad­di­tion to de­ci­sions about where to in­vest, you have to tackle th­ese com­plex de­ci­sions when you use a liv­ing an­nu­ity to pro­vide a pen­sion:

● How much can you with­draw each year so your in­come keeps up with ris­ing costs?;

● How much cap­i­tal is al­lo­cated to the death ben­e­fit?; and

● How much are you pay­ing in charges?

How much to draw.

The flex­i­bil­ity you en­joy in de­cid­ing how much to draw as a pen­sion each year is com­plex be­cause the with­drawal is sub­ject to a min­i­mum of 2.5% and max­i­mum of 17.5% of the cap­i­tal each year.

This means with R1m in­vested in an an­nu­ity you can with­draw any­thing be­tween R25,000 and R175,000 a year.

Matthy­sen says if a 65year-old man in­vests R1m and starts draw­ing out 5.2% of the an­nu­ity cap­i­tal, he can in­crease the pen­sion by in­fla­tion each year and sus­tain the in­creases un­til age 112, close to the max­i­mum age to which ac­tu­ar­ies ex­pect a 65-year-old man to live.

This as­sumes he earns a re­turn of in­fla­tion plus 5%, which is op­ti­mistic and would give him an in­come of R52,000 a year, or R4,333 a month.

How­ever, if the man starts draw­ing a pen­sion at 7% of his cap­i­tal (R70,000 a year or R5,833 a month), he will reach the max­i­mum in­come he can draw from the an­nu­ity at age 80.

At that point he will no longer be able to in­crease his in­come and it will start de­clin­ing in real or af­ter-in­fla­tion terms.

There is a 61% chance that a 65-year-old man will reach age 80, Matthy­sen says.

How much is your death ben­e­fit?

If you in­vest R1m in a liv­ing an­nu­ity at age 65 and you draw out 5.2% as a pen­sion, you are al­lo­cat­ing 43% of your cap­i­tal to a death ben­e­fit.

“That’s pretty large,” says Matthy­sen. It means you aren’t op­ti­mis­ing your al­lo­ca­tion to in­come. You may not even be aware that you are choos­ing be­tween in­come and a death ben­e­fit.

As your draw­down rate in­creases, the value of the death ben­e­fit de­creases, but the like­li­hood of reach­ing the max­i­mum 17.5% in­creases too. Since the death ben­e­fit isn’t a known num­ber, you might be al­lo­cat­ing cap­i­tal to a death ben­e­fit you don’t need.

Moore ques­tions whether ev­ery re­tiree who in­vests in a liv­ing an­nu­ity needs to leave a death ben­e­fit for their heirs.

What does it cost?

Matthy­sen says ini­tial fees are about 1% and on av­er­age liv­ing an­nu­i­tants pay on­go­ing fees es­ti­mated at 2% of the amount they have in­vested. Th­ese are made up of:

● An ad­min­is­tra­tion of plat­form fee of on av­er­age 0.4%;

● An as­set man­age­ment fee con­ser­va­tively es­ti­mated at 1%; and

● An ad­vice fee of on av­er­age 0.6%.

Data from liv­ing an­nu­ity providers shows that 70% of liv­ing an­nu­ities have less than R1m in­vested in them and re­tirees with less than R1m pay higher charges than those with more in­vested, says Matthy­sen.

A to­tal an­nual charge of about 2% a year means in­vestors who buy a liv­ing an­nu­ity are al­lo­cat­ing 20% of their ini­tial cap­i­tal to charges.

The ac­tu­ar­ies were di­vided on whether ad­vice was nec­es­sary.

Re­tired ac­tu­ary Fran­cois Marais says he doesn’t see the need for ad­vice ev­ery year af­ter you make your ini­tial in­vest­ment se­lec­tion as it of­ten leads to un­nec­es­sary switch­ing. You need ad­vice about switch­ing to a guar­an­teed an­nu­ity only af­ter about 10 years, he says.

Matthy­sen says ad­vice is needed for liv­ing an­nu­ities, but ques­tions whether it makes sense to pay th­ese charges or if there isn’t a more op­ti­mal prod­uct.

Pen­sion Funds Act reg­u­la­tions re­quir­ing re­tire­ment funds to set up de­fault an­nu­ities for re­tirees have brought costs down. “But is it enough? I think we can be do­ing more,” he says.

“The ben­e­fits of liv­ing an­nu­ities are com­plex and not well un­der­stood at all, and ad­vice is def­i­nitely re­quired,” says Matthy­sen.

“But th­ese fea­tures come with a layer of costs and the charges def­i­nitely im­pact the value of the ben­e­fits, es­pe­cially at lower lev­els of cap­i­tal.”

Marais says: “Liv­ing an­nu­ities are a good choice if you are very rich or very sick.”

‘Liv­ing an­nu­ities are a good choice if you are very rich or very sick’

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