On 23 July 2020, the South African Reserve Bank announced another 25 basis point cut in the repo rate, bringing it to 3.5%, the lowest it has been in decades. While this does provide relief to consumers in the form of lower interest on debt, there may also be concern in some quarters about the effect of the rate cut on pension income from annuities.
Wayne Dennehy, investment specialist at Momentum Corporate says there’s no need to panic as he isn’t expecting significant change in the cost of future annuities from this cut. He explains, “Broadly, for every 1% change in interest rate, one could expect about an 8% change in the monthly pension your cash can buy. For example, if the money you have can buy you a pension of R1 000 a month, that same money after a 1% rate cut will only buy R920.”
“Markets are constantly moving and so too is the monthly pension that you will be able to buy with your pension savings at retirement. As you approach retirement, what’s key is that your pension fund value moves in line with changes to the purchase price of your future annuity, then there is less anxiety. An example of this is if the value of your pension fund savings drops by, say, R50 000, but the purchase price of your selected monthly annuity also comes down by R50 000,” he adds.
Buying an annuity is a way to ensure a monthly income during retirement. This is what many retirement fund members do when they retire, using all or a portion of their retirement savings. It’s a big purchase decision, so it’s important to consider the features of the different annuity products available to make sure you choose one that best suits your needs.
Many different annuities in the market
The different types of annuities available can be broadly classified under the following categories:
Guaranteed (life) annuity
Living annuity
Understanding what annuity to buy
Dennehy says deciding on an annuity should be part of a complete retirement plan, as everyone’s circumstances are unique. Two important factors to keep in mind are your risk of outliving your retirement savings, and the possibility that inflation will decrease the purchasing power of your monthly annuity income over time.
With-profit annuities
He adds that an annuity that is becoming increasingly popular is a with-profit annuity. This is a guaranteed (life) annuity that pays you a guaranteed monthly income for life. The guarantee includes the initial monthly income and any future increases, which are linked to the investment returns made in the underlying portfolio. These increases help to protect the purchasing power of your pension income. Every time your pension increases, the new amount is guaranteed for life.
Regulatory changes around COVID-19 relief for living annuity owners
Certain changes to regulations were recently published as relief for living annuity policy owners experiencing financial hardship at the moment. The changes deal with two aspects – drawdown rates and cash-out value.
The drawdown rate is the portion of the investment in a living annuity that is withdrawn each year. Between June and September 2020, living annuity owners can change their drawdown rates to anything between 0,5% and 20% (from the normal 2,5% to 17,5%). The regulations normally only allow changes to drawdown rates on the annuity owner’s policy anniversary date, but this relief option allows annuity owners to make a change during this period, even if they’ve already chosen a drawdown rate for this year. After September, the drawdown rate reverts to its previous level.
A living annuity, in essence, reverses the build-up of your retirement fund savings. This means you need to be careful of drawing an income that is too high, which may result in you running out of money in retirement. Living annuities require ongoing monitoring and decision-making to ensure they meet your needs over time.
As of 1 June 2020, you can also take your entire amount as a lump sum if it is less than R125 000. Previously, this amount was R50 000 if you took a cash lump sum at retirement and R75 000 if you never took a cash lump at retirement.
Dennehy concludes, “If you’re at the point of retiring and need to choose an annuity, it is important to speak to your financial adviser or your fund’s benefit counsellor to help you understand which one is right for you.”