Blended annuities – are they ‘just right’ for your retirement?
A priority for South Africans approaching retirement should be to secure an income for life that at least covers essential monthly expenses (e.g. housing, food, water and electricity, transport, phone etc.). Historically, retirement options were limited to either a life or a living annuity. But the good news is that the retirement landscape has evolved, and choosing an annuity for retirement is no longer an ‘either or’ decision.
Managing a pot of assets to achieve a sustainable income for life is actually a complex financial problem. With living annuities, retirees have leeway over how their capital is invested, and how much they take as income each month (within certain limits). But this means that many South African retirees invested in living annuities run the risk of outliving their savings. To enjoy a steady level of income throughout retirement, the industry ‘rule of thumb’ is to only draw down a maximum of 4% of your capital as income each year, yet many retirees are drawing down much more than this.
Consider an alternative approach
You can think of your income-generating retirement assets as two pots of money.
The first pot should aim to generate enough income to meet your essential expenses for life– your bread and butter. The best way to do this is with a life annuity, which provides a stable monthly income that will never decrease, for as long as you live.
The second pot should provide flexibility for discretionary spending or enable you to leave money to loved ones when you pass away – some sugar and cream. This flexibility is provided by a living annuity. You can take on greater risk with this pot to maximise growth as you can afford to cut back on discretionary spending when markets fall.
What are blended annuities?
One way to better manage the higher risk of living annuities and the rigidity of guaranteed annuities is to use a blended annuity, a product that has the best of both in one.
Unlike having two separate products, blended annuities allow you to structure a suitable portfolio over time, balancing the trade-offs of essential and discretionary spending as they arise. For example, you could switch additional tranches into the life annuity component when you need to increase the guaranteed income portion as you age.
Think of it this way. Bread and butter on its own will fill you up and keep you from going hungry. But blend in some sugar and cream, eggs, and even some raisins and cinnamon, and you’ve got a decadent bread and butter pudding!
Why blending is better
Research has shown that combining a living annuity with a life annuity is a better solution for retirement than either on its own. The power of blending allows you to secure a guaranteed income for life to cover essential expenses, while also maximising the long-term growth of the rest of your capital to meet less essential or luxury expenses or leave a legacy to your beneficiaries – in one investment vehicle.
An added benefit is that a blended annuity removes the threat of increasing drawdown risk (having to draw more of your living annuity money as your money runs out). This is because the stable income from the guaranteed life annuity component provides a safety net. So, if assets you are drawing from the living annuity portion ever become depleted, your income from the life annuity will never fall below the guaranteed income level.
Find your ‘just right’ annuity solution
Annuity products have advanced, and new options are available. Do some homework and seek the advice of a qualified financial adviser to help you understand your options to best suit your needs.
Supplied by Ryan Hultzer, Pricing Actuary at Just SA