The benefits of blending: solving the life versus living annuity debate
If you invested your retirement capital in a living annuity, you are able to change your ‘drawdown rate’ annually on the anniversary of your policy. This is the rate at which you draw down your investment to give you an income for the next twelve months.
With the cost of living constantly increasing, it’s very tempting to increase your drawdown rate when your anniversary rolls around. However, this can be very detrimental to your overall financial well-being.
In practical terms, an increase of just one percent, say from 6.5% of your capital to 7.5%, could significantly threaten your ability to have a sustainable income for life.
However, if you really do need to increase your monthly income, there are new options in the retirement income space that allow for a higher income with less risk to your long-term financial security.
Retirement income specialist Just SA developed a new generation, with-profit life annuity that could enable you to increase your monthly income by up to 25% on purchase. In return for the higher income, however, you would need to forgo the flexibility of changing your drawdown rate each year.
Alternatively, if you value the flexibility that comes with a living annuity but want to access a higher monthly income with higher certainty, a hybrid or blended annuity offers a combination of a living annuity and a life annuity that is a more favourable solution than either on its own.
“By purchasing a blended annuity, pensioners can choose where they want to position themselves on the risk spectrum between needs and wants, as blended solutions allow them to decide how much of their living annuity portfolio should be allocated to the guaranteed component and how much should be invested in the market,” says Just SA CEO Deane Moore. “This gives them full discretion to increase their long-term capital growth to meet flexible financial needs or to leave a legacy to beneficiaries.”
A practical example of the different options
A financially astute couple (a 65-year old male and a 61-year old female) have R6 million in retirement savings. They calculate that they need a retirement income of R20,000 per month (around 65% of their household salary) to live comfortably in their golden years. This equates to a drawdown rate of 4% per annum.
The other option is for the couple to secure a with-profit life annuity giving them an initial R25,000 per month (a rate of 5% in normal market conditions) guaranteed for life, with 100% of the income payable while either one is alive. The couple is also eligible for increases on this income, which can never be less than zero.
Alternatively, a blended annuity allows them to allocate a portion of their capital to a lifetime income portfolio within a living annuity investment vehicle, which operates the same as a with-profit annuity. If the couple allocate 50% to the lifetime income portfolio, at a 4% drawdown rate, they can secure an income of R22,500 of which R12,500 is provided by the lifetime income portfolio. To meet their retirement income requirement of R20 000, they only need to draw 3% (R7 500), which is lower than the recommended sustainable drawdown rate in a traditional living annuity. In this way, the couple has retained some flexibility, improved the sustainability of their retirement income while also mitigating longevity and investment risk.
Grappling with the annuity debate
At retirement, investors may grapple with choosing which annuity is best for them, even if annuity options are pre-selected by the trustees of a retirement fund. And once the choice is made, current regulations do not allow living annuities to be split after retirement. However, there is the option to transfer a living annuity to a provider who offers a blended annuity with a lifetime income portfolio.
A blended annuity may serve as a good choice for pensioners looking to balance a guaranteed sustainable income with flexibility. And it is also not an all-or-nothing decision as it is possible to increase the allocation to the lifetime income portfolio at a later stage without splitting, in line with regulations.