Beating inflation in retirement
Why guaranteed annuities deserve a place in your financial plan
Jaco Pienaar,
Business Development Manager, Just SA
At the end of March this year, South Africa’s headline consumer inflation rose for the second month in a row to 7.1% year on year from 7.0% in February according to Statistics South Africa.
Since peaking at 7.8% in July 2022, inflation has remained stubbornly high, putting ongoing pressure on retirees’ incomes.
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 they can buy with that income (referred to as their purchasing power).
In addition to inflation risk, there is also longevity risk, which is where people live longer than they think they will. Just SA research and statistics indicate 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 a 10% chance they will live to celebrate their hundredth birthday.
When planning for retirement income it is vital to understand the different options available to adequately protect retirees from rising inflation and reduced purchasing power and to protect their ability to at least cover essential expenses. This is particularly true for South Africa, where we continue to grapple with the problem that people haven’t saved enough for retirement. Add to this the fact that people are living longer, and that 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.
This is where guaranteed annuities come into their own and why they should form part of a retiree’s post-retirement financial strategy.
What should you consider when choosing a guaranteed life annuity
All guaranteed life annuities provide an income that is guaranteed to be paid for a life me, no matter how long someone lives 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.
- It is important 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, consider the death benefits that are available with your guaranteed annuity. There is a choice of one or both of these options:
- A minimum payment period during which the full income will be paid to a spouse or dependents, regardless of when the policyholder (or their spouse or dependents) passes away.
- A spouse/partner income benefit, where between 50%and 100% of the full monthly income can be paid to a spouse/partner for the remainder of their life, after the main life passes away.
An enhanced life annuity
Underwriting at retirement is a fair way of ensuring you get the right income, for life. The answers provided during the assessment allows the insurer to determine a starting income based on the insured’s individual life expectancy (not the average life expectancy). If the assessment results in a shorter-than-average life expectancy, they can qualify for a higher starting guaranteed income. Retirees should consider spending a bit of me doing underwriting to give them the confidence that they are getting the highest possible starting income for their retirement savings.
What about living annuities?
Living annuities were introduced in the early 1990s in response to the perceived limited flexibility of life annuities. They give retirees the ability to have some control over how their savings are invested (ideally with the help of an accredited financial adviser) and to decide how much income to draw from their capital within the prescribed limits of 2.5% to 17.5 per annum. However, unlike guaranteed life annuities, their ability to provide this income – for life ― is dependent entirely on market returns.
Leaving a legacy
Both life and living annuities allow for leaving money to loved ones, but in different forms. Any remaining balance from a living annuity is automatically passed on to beneficiaries. However, with a guaranteed life annuity, there is a need to opt for further promises or guarantees to ensure beneficiaries receive an income when the main life assured dies.This could be in the form of a minimum payment period (or guarantee period) or a spouse/partner’s annuity, which means the second life assured will receive the income, or a portion of the income, when the main life passes away.
Blended annuities – a bit of both
A solution on that combines both a guaranteed annuity and a living annuity can help to reduce all of the risks mentioned above. This is called a blended annuity in that it blends a life annuity inside of a living annuity so retirees can:
- receive a guaranteed income for life, and;
- have a measure of flexibility in terms of how the rest of their re rement savings is invested and how much to draw from that investment.
A reminder that when it comes to managing your financial resources, no matter what the level of understanding, seeking help from a financial adviser is strongly recommended.
