Dare to compare - Selecting the right annuity for your client

01 April 2013 Mickey Gambale, Momentum Wealth

You may have been following the recent debate in the media on an investment-linked living annuity (illa) vs. a guaranteed or life annuity. A paper, delivered by Mayur Lodhia and Johann Swanepoel, at the Actuarial Society of South Africa, sparked the discussion. The paper compares the ability of living and guaranteed annuities to provide a minimum real income for life. It also shows the often overlooked benefits of mortality pooling and how purchasing a guaranteed income stream may benefit you.

I believe the paper was misunderstood by many, amidst comments from the audience arguing that the increase in sales of living annuities were driven by distorting factors such as skewed incentives to financial advisers and a lack of proper insight into illa product design. The paper further states that the evidence points to a significant threat to the financial stability of pensioners (outliving their capital), the reputation of the actuarial profession, the government/regulators (added burden of possible increase in old-age grants) and the financial industry as a whole (accused of mis-selling illas).

In search of a fair and sustainable annuity

This followed shortly after the release of technical discussion papers by National Treasury on promoting household savings and retirement reform. Essentially, Treasury want to set new rules for living annuities to reduce complexity and bring down costs, making it more competitive.

They are also proposing default options with longevity protection for the first R1.5 million of retirement funds, only allowing living annuities or retirement income trusts (rits) for amounts above the first R1.5 million.

But, is it fair to compare a life and a living annuity?

If you are comparing these products, you are guilty of making a classic mistake! Different people want different things out of life. Now, and throughout all the changing seasons of life. The same applies to retirement needs.

The overriding reality is that one should be very careful when choosing a pension product, as the obvious and most popular choice might not be the right choice for your client. Both living annuities and guaranteed annuities have their place in financial planning and both play a very important role in post-retirement planning.

In essence, a life annuity is an insurance product and not an investment product, whereas a living annuity is an investment product and not an insurance product. A classic case of different needs...and fundamentally different products.

How to decide

Consider the following needs your clients could consider before making a decision:

In short, it seems like people misunderstand life annuities because financial experts tend to focus on saving for retirement and, to a large extent, investment returns and return management. Life annuities are not about high return, but rather about risk management and, specifically, the risk of your clients outliving their capital.

Furthermore, the current low interest rates could mean a lower payout from a life annuity, however, the reason your clients are buying guaranteed life annuities is because they want the absolute assurance of having that income in their bank account every month, for life.

Is any annuity going to pay enough?

The answer to this question depends on how much your clients have saved for retirement. This is really the only factor they can control. In fact, the sooner they start, the better their chances for a comfortable, sustainable retirement income. So, whether your client chooses a life annuity or a living annuity, it will never be a solution for saving too little in the first place.

And, where does this leave the role players and the industry as a whole? As the people in the know, our purpose should be to create responsible solutions for stress-free living and a comfortable retirement for all our clients.

We need to continue to educate clients to gain a better understanding of the trade-offs between living annuities and guaranteed annuities.

We need to also help retirees understand the impact of drawing down too much income (especially in the first five to ten years of retirement), as well as the risks they need to take when they choose to buy a living annuity.

We need to continuously monitor and support our products and advice to make sure our clients have a sufficient meaningful income in retirement.

Bottom line? We are in this together – product providers, actuaries, intermediaries, regulators, media and clients. May we all succeed in creating a sustainable outcome for this debate.

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