Simplifying the complexities of retirement annuities
The future looks bright for the next generation of retirees – we’re living longer, with the number of South African centenarians increasing every year. It is expected that Africa’s population of older adults will more than triple, from 46 million in 2015 to 157 million by 2030 (WHO 2015). We’re also approaching retirement age with a greater sense of purpose.
This longevity requires us to deliberately think about ways of funding our retirement. With more life to look forward to and more passions to pursue, it’s essential that we build a nest egg that lasts our full lifetime. This is where annuities come in.
Over the years, the various types of annuities have attracted both fans and critics through a variety of perceptions and misconceptions. Let’s debunk a few of the more common myths about annuities.
The word ‘annuity’ is used in different ways in financial products so it can appear complex. It is important to understand what each of them mean so that it is clear where and when to use them.
A retirement annuity is a savings vehicle that offers a very tax efficient way of saving towards retirement. In this type of product, a client contributes regularly, and the money grows in the investment components that they choose. The aim is to accumulate as much as possible to be able to get a higher income during retirement.
Retirement annuities are a common means of savings, in tandem to retirement vehicles like pension and provident funds made available by an employer. It is also the most effective way for self-employed people to save towards their retirement. The important part is that you use a retirement annuity to save for retirement. At retirement, part of the accumulated retirement savings must be converted into an income stream.
There are two broad types of annuity products used to provide an income during retirement.
Living annuities are market-linked investments designed to give clients a regular retirement income, while simultaneously aiming to grow their retirement savings. A small portion is withdrawn from their retirement savings each month to provide them with a regular income. The market value of the living annuity will vary, depending on the performance of the underlying investment portfolios, and the level of income they withdraw every month.
Life annuities pay a regular income for life to the client, protecting them against market fluctuations. The insurer guarantees that the income you receive will never reduce for as long as you live, so you can’t outlive your income. This type of an annuity is typically ideal to match one’s basic life expenses such as medical costs, groceries and other regular essential spending.
There is a better way for people to, together with their financial adviser, plan and structure their finances when they retire to blend their need for certainty and flexibility.
A combination of a life and living annuities can provide the best of both worlds.
As market volatility and inflation continue to rise, it’s crucial for clients to gain a full understanding of a process that may occupy them most of their lives. Clients need to understand the importance of contributing towards their retirement while they are employed and earn an income. The more you contribute and the higher your growth rates, the more you will be able to ‘earn’ during your retirement. It is important to know the difference between pre-retirement vehicles and during retirement vehicles that allow one to have a sustainable monthly income.
Contact a financial adviser to truly understand the benefits and functionality of annuities on your journey to success.
Fareeya Adam is head of product solutions at Momentum Investments