Here are the basics of a traditional life assurance annuity:
You receive a fixed amount from the annuity for life. Once bought, it cannot be swapped.
The annuity can be linked to inflation or another pre-specified figure for a fixed annual growth. If you choose a level annuity without an inflation adjustment, you will rapidly reduce your spending power as a result of inflation.
You can add a death benefit. You can make your partner one of the beneficiaries for life, or guarantee an amount that will be paid as a pension to you or your dependants for a fixed number of years, whether or not you are alive.
You can also purchase a with-profit annuity, which guarantees your initial pension. Future increases will depend on investment market conditions and how the underlying markets perform. But with-profit annuities also smooth out the market returns, paying you less in good years and paying out more in bad investment market years.
Once an increase is granted it cannot be taken away in the future. If you have a with-profit annuity, even with the markets performing badly because of the COVID-19 pandemic and South Africa’s losses to kleptocracy, you will never receive less than you are already being paid. What is likely to happen is that you will receive lower (or zero) increases in the years ahead, but what you receive now is guaranteed.
And here are the basics of a living annuity:
You can draw down between 2.5 and 17.5 percent of the capital amount annually. This is apart from the four-month COVID-19 crisis change by the government to decrease or increase from the current minimum of 2.5 to 0.5 percent and the current maximum of 17.5 to 20 percent for four months. You can also increase or decrease by any amount within the scale.
The government’s COVID-19 exemption will make little difference. According to Alexander Forbes’s research, if you increase your pension by 1 percent, it will reduce your point of ruin by half a month, and for 2 percent by a month.
The lower the drawdown you choose, the more likely it is that your living annuity will last and you will delay reaching a point of ruin.
You decide on the underlying investments either on your own or with the help of a financial planner. This is where many investments have failed over the years, as the underlying investments were too high risk for an income-based source of money.
You can leave what is left of your living annuity to dependants. The problem, however, is that very few people will die with much left in their retirement funds.
The average initial income drawdown rate for pensioners who have retired from funds administered by Alexander Forbes is 6.42 percent in 2019. The Alexander Forbes rate has been increasing.
Anderson says that these figures do not reflect the true story, as they are based on averages and skewed by pensioners with a large amount of retirement capital (who typically have much lower drawdown rates). Other research in the survey shows that of the total pensioners surveyed at the time of their retirement,
between 70 and 77 percent of pensioners had capital of less than R1 500 000 and drawdown rates higher than 5 percent;
between 24 and 36 percent of pensioners had capital of less than R1 500 000 and drawdown rates higher than 7.5 percent; and
nearly 25 percent of pensioners had capital of less than R600 000 and drawdown rates higher than 10 percent.
According to the Alexander Forbes research, the above findings mean that the averages hide the fact that people who have saved enough for retirement have very low drawdowns, while those who have saved too little for retirement have high drawdowns.
The averages also conceal that those pensioners who took up living annuities over the last 20 years and who have increased their drawdown rates at a faster-than-recommended pace are now in even worse trouble. The COVID-19 outbreak and the damage done by kleptocracy, with the resulting market impacts and the credit rating downgrade by Moody’s, mean reduced investment returns into the future.
The research shows that the problem with this is that in the long run, and depending on other resources at their disposal, pensioners are likely to run out of money at a time when it is too late for them to do anything about it, as they may be too old and/or too ill to get another job.
Longevity
Longevity is another factor that is becoming increasingly important for retirees to keep in mind. The information below shows how crucial this issue is when planning your financial future:
People will be living for longer and longer. The average date of death at age 60 is 79 for males and 84 for females. And the longer you live, the more money you require. Many more people are living into their 90s and will need more money than those who die before the average age.
Longevity problems are then compounded by the following factors:
The age at which you retire has an impact on your finances. Early retirement means the loss of both income and further savings, and the loss, if you are employed, of other service benefits. Of the number of people surveyed by Alexander Forbes, about 50 percent of members retired on their normal retirement date, 36.5 percent retired early and 14.95 percent retired late. In 2019, the average age of retirement was 63.
The contributions you have made towards retiring are critical. A separate Alexander Forbes survey, Member Watch, in which more than one million contributing members are measured, shows that higher contributions and length of service are critical to securing a reasonable retirement income.
To receive a replacement ratio of 70 percent, you need to contribute from both yourself and your employer the following amounts at retirement, age 65: if you start at age 20, you need a contribution rate of 13 percent; or if you are age 25, you need a contribution rate of 17 percent. These are contributions from both you and your employer.
If you aim to retire at age 60, you will not achieve a replacement ratio of 70 percent under the above scenarios.
Anderson says that if you retire at age 65 rather than at age 55, you will almost double your replacement ratio, assuming you started to save at age 25. Given current market conditions following the COVID-19 outbreak and Moody’s downgrade, delaying your retirement and staying employed for longer on a full- or part-time basis, if possible, may be a good approach.
Inflation for retirees typically rises above the average inflation rate. The reason for this is medical aid, where the rate of inflation is higher than average inflation. You will spend an estimated 60 percent of your money on medical claims after you turn 60. The result of earning too little as a pension means that many pensioners are dropping out of medical schemes or downgrading to a lower option at the very time they need medical aid most. And the longer you live, the greater the impact will be.
Some good news
There is some good news, however, for people who are approaching (or are even in) their retirement, if they have some money to spare.
In 2019, the average contribution rate of retirement fund members was 14.44 percent, but most of this (9.14 percent) came from
