• Bruce Cameron

Alternative ways to structure a pension

The best way to overcome the disadvantages of living annuities and guaranteed annuities is to use both. This becomes even more important with Covid-19 and the downgrading of South Africa’s credit rating.

The big difference between the two generic types of pensions (annuities) is: with a guaranteed pension, you take no risk, but with an investment-linked living annuity (living annuity) you take all the risk.

There are advantages and disadvantages to both.

The big question remains: why do 90% of pensioners use living annuities in preference to guaranteed annuities when research undertaken by Sanlam and Just SA finds that between 81% and 87% of retirees want a secure income?

Actuary David Gluckman, chairman of the Sanlam Umbrella Fund and head of Sanlam Special Projects, says at the point of retirement the vast majority of members are not yet ready to make a binding commitment for the rest of their (and their spouse’s) life on their pension.

“There is a genuine need for optionality, and particularly because the vast majority have simply not accumulated sufficiently. Financial advisers might well consciously or unconsciously play on this need in promoting living annuities, but nonetheless it remains a genuine need.

“Until this is solved, I suspect it will be difficult to massively increase the take-up of guaranteed annuities (unless there is massive regulatory intervention). I also think the need for a living annuity diminishes a few years after retirement once pensioners are more in tune with the realities of retirement.

“If somehow in product design we can build in some flexibility in the first few years after retirement, I suspect the take-up of guaranteed annuities around the age of the early 70s could substantially increase. So, there is a human behaviour element to this puzzle. Theory and practice are somehow at odds.”

Deane Moore, chief executive of Just SA, a life assurance company that blends living and guaranteed annuities, says this question is often asked the wrong way as: “How soon will I die?” rather than as: “How long will I live?”

If you are well off, have a low drawdown rate and lower-risk investments, then you may only need a living annuity.

The mixed annuity products are called “hybrid” or “flexible” or “blended” pensions, allowing a more versatile and lower-risk approach to providing an income.

Moore sums it as the pensioner thinking of her retirement money being in two pots.

  • Pot 1: Using a guaranteed annuity to sustain them financially for life, no matter how long they live. This is a “no regrets” decision in that it deals with the question of, “What happens if I live past tomorrow?”

  • Pot 2: Using a living annuity for flexible spending; or to leave the residue capital for beneficiaries. In other words, it answers the questions of, “What happens if I die tomorrow?”

Some other differences you need to keep in mind in structuring your pension:

  • You can always transfer out of a living annuity, either to another product provider, or to a guaranteed annuity.

  • Once you have a guaranteed annuity you cannot transfer out of it either to another provider to switch back to a living annuity.

  • Another major advantage of using a hybrid annuity is that as you get older you could start suffering from dementia. By that stage, if you are fully invested in a guaranteed annuity, you will have far less chance of being ripped off.

  • You can use a hybrid annuity from the start of your pensionable years, or later on when the guarantee annuity rates are much higher.

  • The returns for a guaranteed annuity get better the older you are. Moore gives the example of a male pensioner who buys a profit annuity with R1-million, in a balanced portfolio that would increase at a rate equal to inflation at CPI+4% over the lifetime of the pensioner, with no guarantees or provisions for a spouse.