The tricky balance between retirement earnings and death benefits

The more income you require from an investment living annuity, the less the death benefit your heirs will receive. As one goes up, the other goes down. There are also other costs that can be huge.

 

Over the last two weeks, I dealt with some of the pros and cons of guaranteed annuities versus living annuities, based on the table below used by living annuity product providers. Today, I will deal with: leaving money to an estate and costs (the costs are not included in the table, but make up an important element).

 

The table is based on this simplistic approach prepared in the past by the linked investment service provider (Lisp) companies.

 

Leave to an estate

 

When you die, with a living annuity, the residue of your investment is passed on to your beneficiaries.

 

But this does not mean a guaranteed annuity provided by a life assurance company simply claims your capital when you die, as is implied by the table.

 

Deane Moore, chief executive of insurance JUST SA, says: “I’ve seen some horrific, incomplete and frankly dishonest half-truth comparisons in the market-place, such as a living annuity provides your capital back on death, while, with a guaranteed pension, the assurer keeps your remaining capital.”

 

Moore says the “guarantee” of a guaranteed annuity comes in three forms:

 

  • You are guaranteed the annuity payments for as long as you live. The payments to people, who live beyond their life expectancy, are funded by capital left behind by those who die before their life expectancy. It is a form of life assurance in which a group of policyholders pool and share risk. By contrast, a living annuity is self-insurance and only provides reasonable payments after your life expectancy, if you have had very low drawdowns initially prior to that. Moore says typically a low living annuity drawdown will be less than the guaranteed annuity rates.

  • You can leave a percentage of your income (typically 50% to 100%) to your spouse on your death – it is an income legacy, whereas a living annuity leaves a capital legacy. In the early years, the cost of an income legacy, even if set at a continuation of 100% of income to the spouse, is usually less than the value of capital left behind on early death in a living annuity. The cost of that “additional death benefit” in a living annuity is reflected in having to maintain a drawdown rate below guaranteed annuity rates to be confident of sustaining income beyond your life expectancy.

  • You can also insure that your payments will continue for a certain period whether you are alive or dead. So you could buy an annuity where the income lasts for 10 years and is paid to your heirs if you die early on.

 

Moore says with both annuities, you can leave your income flow to your partner without tax consequences. With a living annuity, the entire residual capital is left (after the withdrawal of your income), but with a guaranteed annuity, you can decide on what you would like to leave to your partner. The more you buy for your partner, the lower your income will be over the years.

 

Actuary Warren Matthysen, principal investments consultant at Alexander Forbes, has put together the following charts to illustrate how the playoffs occur in a living annuity between income and what you leave to your heirs.

 

He assumes a male pensioner, who uses a R1-million living annuity, retires at age 65. The inflation rate for the period is assumed at 6%. He uses four different drawdown rates.

 

  • 5.2 %. This is the best rate for sustainable pension, even if you live to 113 (the maximum age that it is assumed anyone can live to).

  • 6% is the recommended initial drawdown recommended by The Association for Savings and Investment SA.

  • 7.5% is the initial drawdown used by pensioners from Alexander Forbes research.

  • 17.5% is the normal top drawdown allowed. This is the maximum permitted drawdown that is being labelled as “the point of ruin”. Once you reach the point of ruin, your rand income will decrease in nominal and real (after-inflation) terms.


This table deals with your pension relative to the point of ruin: