Unpacking investment-linked living annuities


No one generic pension fund product provider is better than another. They offer different solutions to different people. But research by Alexander Forbes shows that not enough research  is actually done, particularly in the first 10 years, to establish the best solution.


If you have sufficient capital on which to retire, you can use almost any retirement annuity on offer and preferably a combination of a living annuity and a guaranteed annuity.


But, even if you retire with sufficient capital, and then make mistakes in investing your retirement capital, you are likely to become unstuck. 


The one thing all retirees and soon-to-be retired people need to know is how to manage their investments to ensure it provides a sustainable income, given these repeated shocks. These shocks are likely to get worse and, in particular, need to be taken into account by people who are in the disinvestment stage of their lives.


I am going to deal with the main selling points of living annuities made by product providers and what you must take into account. 


Right now, 90% of pensioners, by amount, buy living annuities, investing R585-billion in 2018, with all their risks, as opposed to traditional annuities, where you carry little risk.


Living annuities come with a lot of complex risks, which most people do not understand or are able to manage.


Research by Alexander Forbes shows that many retirees with living annuities were already in serious trouble, even before the Covid-19 pandemic, the downgrading of South Africa’s debt and the market crash. 


Last year, at the Actuarial Society of South Africa’s annual conference, Warren Matthysen, principle consultant at Alexander Forbes Investments, asked why so much money was allocated to living annuities as they are seldom optimal if they are intended to provide maximum income in retirement.


He questioned if people never really understand what they are buying, and if they understand the charges and opportunity costs associated with living annuities.


Matthysen told the conference that living annuities have two-component benefits, one being the income and the other, the death benefit. 


“But we can’t place a value on these benefits as no one really knows what they will be,” he said.


The best way to look at the pros and cons of living annuities is to use the product providers simplistic diagram used to promote them.


Here is the diagram:

I will deal with an adequate initial income and inflation this week and the other three next week.


An adequate initial income


The diagram shows that an adequate “initial” income is less certain if you used a guaranteed annuity (pension) provided by a life assurance company, where your pension is guaranteed for life.


But the product providers claim that the “initial” pension provided by a living annuity is likely to be spot on. 


But “initial” is the key word. My quotes.


If you give me R5-million, I can guarantee you the “initial” income for the first 12 months, simply by dividing the amount by 12, after deducting all the fees and costs.


The question should not be: “initial” payment of an income. The questions that need to be asked are: What will your income be in 10, or 20-years time; and what happens if you live to be 100?


Matthysen’s argument stands up here, namely whether your pension will last, at the required level with inflation increases to sustain your income needs, until you die.


It is the long-term effects that need to be dealt with and this will be determined by the following number of unknown factors. 


The only answer is to provide assumptions, looking at both the worst case and the best-case outc