By Rocco Carr, Business Development Manager
For the past two decades clients have tended to prefer a living annuity to supply their retirement income, rather than some of the more traditional guaranteed options. This made sense during a period where guaranteed rates were relatively low and market returns were far above normal. An additional driver behind this choice was also the benefit of an inheritance for one’s children.
A low-return environment and your investment
However, over the past four years, market returns have dwindled sharply and suddenly investors are battling to keep their capital amount stable while they are drawing an income. This leads to pressure on income levels and ultimately increases longevity risk (the risk of outliving one’s capital), which is real.
One should keep in mind that the purpose of retirement money is to supply a member and his or her spouse with an income until the longest living spouse passes away. If there are any funds left at that stage, inheritance is a bonus, but not a right.
According to Glacier guidelines, a couple aged 65 should not draw an income of more than 4.2% – with males at 4.9% and females at 4.2%. The reality, however, is that most retirees need more income than this guideline which means that should one of the spouses live past the normal life expectancy age, the capital will not be enough to support the income need. In fact, this will imply that instead of inheriting any money, the children will inherit the parents and their expenses.
In an age where technology allows for people to live far longer than in the past, inheritance should not be the biggest driver of where retirement money is invested.
Combining different solutions for best effect
By combining a living annuity (ILLA) with the Glacier Investment-Linked Lifetime Income Plan (ILLI), the investor gets the best of both worlds. Unlike conventional guaranteed products, the ILLI still uses an underlying portfolio of funds to determine future income levels. However, this portfolio is unitised and guaranteed until the death of the longest living spouse. As the income units are guaranteed, no units need to be sold to supply the income during a tough period in the markets.
It’s acknowledged that investors need to take more risk to fight the impact of longevity, but in a living annuity investors often need to sell off units to supply a stable income during volatile markets. Many investors cannot stomach this volatility and then they opt for something more conservative.
The ILLI, with the unit guarantee, therefore allows for a portfolio of more risk than one would normally be comfortable with in an ILLA. After the death of the longest living spouse, the capital invested in the ILLI will fall away while the capital in the ILLA will still be available for an inheritance.
In a typical combination, one would have 30% of the portfolio in the ILLI, with 70% of the portfolio in a living annuity. The living annuity still retains the advantage of inheritance, but should one of the members live longer than expected, the income from the ILLI will ensure far better income than from a 100% living annuity.
The purpose of the split is therefore to protect income at old age, thus creating stability at that stage.
Who should consider this route?
The combination is specifically aimed at people who need to draw an income in excess of the guidelines provided. Depending on age, it works best for people who need an income of more than 4%, but less than 9%. As a rule, it allows a person to draw an income of about 1% to 2% more than the normal guidelines without spelling total disaster should one or both of the spouses live past the normal life expectancy age.
The portion of the investment that cannot be inherited should almost be seen as a single premium insurance policy supplying an income should one outlive one’s capital. In a projection of a couple, both 63 years old, taking a 6% income with an inflation-adjusted growth in income on a R6 million investment – the projected annual income from the ILLI / ILLA combination at age 90 is R810 000. This is more than three times the R240 000 expected annual income from the living annuity.
In an age where outliving one’s money is a serious risk, the ILLA / ILLI combination is perhaps one of the best solutions available in the post-retirement space.