Guaranteed Annuities: Why they should be part of your post-retirement plan in a high inflation environment

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Article by Jaco Pienaar, Business Development Manager, Just SA

In the last statement of the Monetary Policy Committee, Reserve Bank Governor Lesetja Kyanyago described inflation as “sticky” and revised the Bank’s expectation of headline inflation this year from 5.4% to 6.0%.  This is a significant increase and should be factored in when choosing a retirement product to provide an income.

Inflation is typically measured by the Consumer Price Index (CPI), which relates to a basket of goods that an average person will buy. But in retirement, it is important to recognise that a pensioner may also experience different types of inflation like medical or lifestyle inflation (the rising medical or lifestyle costs associated with ageing), which can be greater than CPI. Essentially, inflation doesn’t affect a pensioners’ income; what it does affect is what you can buy with that income (i.e., your purchasing power).

It is vital to understand the different product options available to you when you retire so that you can protect yourself from rising inflation and reduced purchasing power and protect your ability to at least cover your essential expenses.

The options

There are essentially two options to choose from to provide an income in retirement. You can either lock in a monthly income with a guaranteed life annuity or take more of a risk with what investment markets deliver in a living annuity. Or you can do a bit of both. In addition to inflation, there is longevity risk, which is where you live longer than you think you will.  Internal statistics from retirement income specialist Just SA indicates a total life expectancy for a 65-year old to be 87 years for women and 82 years for men, with 25% of women at age 65 likely to reach 94 and 10% living to celebrate their hundredth birthday.

In South Africa we grapple with the problem that people haven’t saved enough for retirement. Added to this is the fact that people are living longer, and market returns are unpredictable, so retirees need to ensure their retirement income product can be resilient in the face of uncertainty and at the very least cover their essential expenses.

What should you consider when choosing a guaranteed life annuity?

All guaranteed life annuities provide an income that is guaranteed to be paid for your lifetime, no matter how long you live or what happens to investment markets.  There are three main variations to select from:

  • A with-profit annuity targets future increases of either inflation, or a percentage of inflation.
  • An inflation-linked annuity guarantees that future increases will be equal to CPI.
  • A fixed escalation annuity provides a guarantee that future increases will be equal to a fixed percentage each year. The percentage is agreed to upfront.

You need to consider the relative value of each type of guaranteed annuity, as well as the starting income and increase potential (after all fees).

And finally, you should consider the death benefits that are available with your guaranteed annuity. You can choose one or both of these options:

  • A minimum payment period during which the full income will be paid to your spouse or dependents, regardless of when you (or your spouse or dependents) pass away;
  • A spouse/partner income benefit, where between 50% and 100% of the full monthly income can be paid to your spouse for the remainder of their life, after you pass away.

A bit of both

A solution that combines a guaranteed annuity and a living annuity can help to reduce all four of the risks mentioned above. This is called a blended annuity in that it blends a life annuity inside of a living annuity so that you can:

  • receive a guaranteed income for life, and;
  • have a measure of flexibility in terms of how you invest the rest of your retirement savings and how much to draw from your investment.

A reminder that when it comes to managing your financial resources, seeking help from a financial adviser is strongly recommended.