Best to hedge your pension options – Business Day (registration)

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If you chose to receive an escalating income from a guaranteed annuity, the income drawn from your capital could be lower than the yield you could earn from investing in a government bond, he said.

Life assurers invest mostly in bonds to provide you with the income they pay you when you take out a guaranteed annuity.

The income offered on guaranteed annuities should therefore increase or decrease in line with bond yields, but Craig Gradidge, an independent financial planner with Gradidge Mahura Investments, said guaranteed annuity rates did not appear to have increased despite increasing bond yields.

Andrew Davison, the head of implemented consulting at Old Mutual Corporate Consultants, said it was not true that a bond could deliver a superior return.

You would need a 35-year bond to ensure an income from age 65 to 100 – the age you need to plan for because people were now living for longer, he said.

A guaranteed annuity can deliver a higher pension than the interest and capital repayments you could get from a 35-year bond because annuities pool investors’ capital and the annuity payments are based on the average life expectancy of the group, which will be lower than 100.

Davison said the pricing of guaranteed annuities should be more transparent, but retirees should not underestimate the benefit of the insurance such policies provided against the high risk of outliving one’s savings. “We typically insure our cars and homes, but at retirement most of us choose to use a living annuity without any insurance against a key unknown factor — how long you are going to live,” he said.

Old Mutual tested the ability of a R1-million living annuity to sustain an initial income level of 6.5% of the capital, increasing by inflation each year.

It tested 75 annuities with starting dates six months apart from January 1951.

 The annuities were invested in balanced portfolios of equities, bonds and cash and the average real (after inflation) return was 5.5% a year over the entire period.

However, the sequence in which good and bad returns were earned, combined with the consistent income withdrawal, resulted in 42 of the 75 annuities failing to sustain the required income, Davison said.

The shortest period over which an annuity supported the required income was just 13 years. Fourie said the best option was to use both a living and a guaranteed annuity, but annuity providers needed to do more to enable the combination to work for you.

You should be able to initially split your capital between a living and guaranteed annuity and then to slowly migrate capital from the living annuity to the guaranteed annuity, he said. Life companies should be able to offer guarantees on living annuities, and the administration fees should not be charged as a percentage of the amount invested, Fourie said. Finally, you should be allowed to reduce your withdrawal from a living annuity to zero, he said — currently you must withdraw at least 2.5%.

This would enable people to use a guaranteed annuity for their basic income needs and to withdraw from a living annuity only when investment markets favoured this, or when they needed to access funds, for example for medical expenses.

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