The FAIS Ombud’s theme for the 2021/2022 Financial Year was, “Evolving our services with the future in mind”. And over the last year, the Ombud has focused on increasing awareness of consumers’ rights when it comes to financial advice.
Financial Service Providers have a responsibility to ensure that consumers are provided with the necessary information to make informed decisions – with or without the help of a financial adviser. While we at Just SA believe this is important throughout a client’s life stages, it is critically important at retirement when they often need to choose between a living and a life annuity.
In the latest annual report, Adv. Nonku Tshombe states: “In South Africa you have two choices in this regard – a guaranteed annuity, or a living annuity. A living annuity is an investment product that, unlike a guaranteed annuity, transfers the risk and responsibility of securing an adequate income for life onto the shoulders of the consumer.”
Security comes first
According to Just Retirement Insights, many people rank the need for certainty that their retirement income will last as the most important consideration. This is a key feature of a life annuity. However, in practice, many retirees choose to defer annuitisation or not to annuitise at all, which is the opposite of what they articulate as being important, and what is deemed optimal in retirement.
At retirement, some individuals could be expected to make potentially life-changing decisions about how much income they need each month, for the rest of their lives. And they do not necessarily have the luxury of time to understand their options.
“And so begins the constant struggle between what is the appropriate drawdown rate and what is the optimal asset allocation that will not only supplement the income drawdown but exceed it to ensure that the annuity remains sustainable in the long term,” Tshombe continues.
Are your clients in the danger zone?
The FSCA determined maximum drawdown rates by age band and gender to try preserve sustainability. For example, a sustainable drawdown is considered to be 5.5% for males at age 65, 5% for females at age 65, and 4.5% for a couple aged 65.
We believe there are three possible scenarios or zones for living annuitants depending on their current drawdown rate, and in relation to the FSCA’s recommended drawdown rate for living annuitants.
Safe zone: Drawing an income at a sustainable rate. The safe zone indicates that it is highly likely that their drawdown strategy or approach will remain sustainable from an income point of view.
Risky zone: Drawing an income that is above the recommended sustainable rate, but below life annuity rates. The risky zone indicates that income will only remain sustainable if all or at least a portion of the income is secured – or guaranteed – which can be achieved with a guaranteed life annuity.
Danger zone: The danger zone indicates that their income drawdown or withdrawal rate is not sustainable, and they risk running out of money in the future.
In a recent study using a large sample of around 10% of the annuity market, we found that 2 out of 3 living annuitants are drawing more than the recommended sustainable drawdown rate. We believe half of these (i.e. 1 out of 3 of all living annuitants) could secure their current income for life, with inflation protection, without having to reduce their drawdown rate.
A modern annuity solution
Just as the Ombud is evolving with the future in mind, so is the retirement industry. New-generation annuity solutions can be tailored to suit an investor’s unique circumstances and risk appetite at retirement. A blended annuity combines the benefits of a living annuity and a life annuity in one investment. This could be a more suitable way to better manage the higher risk of living annuities and the rigidity of guaranteed annuities.
Unlike having two separate products, blended annuities allow you to structure a suitable portfolio over time, balancing the trade-offs of essential and discretionary spending as they arise. For example, you could switch additional tranches into the life annuity component as required to increase the guaranteed income portion as clients age.
Advice is still key
It is vital that consumers understand the different retirement income options available when they retire to protect themselves from rising inflation and reduced purchasing power, and most importantly increase the propensity to cover essential expenses for life.
Careful financial planning in the years leading up to retirement is important to make sure clients are in the best possible position to choose an income structure that suits their retirement needs. And seeking independent financial advice at retirement is even more important to gain a better understanding of the annuity products best suited to individuals’ circumstances before they make any decisions.