How to align a lifestage strategy with annuity choice at retirement

Danie van Zyl, head of guaranteed investments at Sanlam Employee Benefits.

Lifestage investment portfolios have increased in popularity among retirement funds over the past few years. They are delivering competitive results, and offer an excellent solution to fund member apathy with regards to investment choices. For a lifestage model to be successful, however, it is crucial that the investment strategy during the last few years before retirement is aligned with a member’s final annuity choice, says Danie van Zyl, head of guaranteed investments at Sanlam Employee Benefits.

“The five years before retirement are when a member has built up the largest fund value. A carefully considered asset allocation strategy at this stage is imperative not only for the protection of value, but also for securing a required retirement income, and ensuring that the investment keeps pace with inflation,” says Van Zyl. 

The results of the 2015 Sanlam Benchmark Survey revealed that 61% of retirement funds surveyed indicated they were offering a lifestage portfolio – providing members with the opportunity to invest in a single strategy appropriate for the whole of their savings careers. The portfolio de-risks automatically as individual members grow closer to retirement. 

The survey showed that only 54% of the funds with lifestage strategies align their end stage strategy with a member’s annuity choice at retirement, however. Not even a third allow for more than one end stage depending on a member’s selected annuity choice before retirement. 

Van Zyl says asset allocation strategies can easily be tailored around the type of annuity a member has chosen. Most funds offer the following three default annuity options: 

• Inflation-linked annuity: This provides pensioners with an income for life that is guaranteed to increase with inflation every year. The cost of the annuity decreases or increases as real interest rates move up and down. “The best way to protect members’ ability to purchase the same level of inflation-guaranteed income at retirement would be to invest in a portfolio in the end stage that aims to track the cost of an inflation-linked annuity. These types of portfolios invest mainly in inflation-linked bonds,” says Van Zyl. 

• With-profit annuity: A with-profit annuity provides pensioners with a guaranteed income for life, with increases declared annually by an insurance company. Increases depend on the portfolio’s underlying investment return, how long pensioners are living and the insurer’s smoothing philosophy. 

The cost of a traditional with-profit annuity is not as sensitive to changes in interest rates as an inflation-linked annuity. This reduces the need for members to invest in inflation-linked bonds close to retirement. However, many members are still hesitant to invest in a high equity portfolio due to the volatility of equity returns and the risk of seeing their capital reduce before retirement. “Members can enjoy meaningful equity exposure without the risk of seeing negative returns by investment in a smoothed bonus portfolio,” says Van Zyl. 

• Living annuity: A living annuity gives pensioners great flexibility in how to invest their retirement savings and on how much of these savings they want to withdraw annually in the form of a pension. However, these annuities do not provide members with a guaranteed income for life, while poor investment returns can lead to a lower income later in life. Van Zyl says given the flexibility and range of choice that members have in these living annuities, they often try to align their investment choice pre-retirement with their investment after retirement by investing in the same portfolio for both.