As we’ve mentioned in our very first RA blog, at least two-thirds of your RA or pension needs to be converted into an annuity upon retirement. But one does not simply buy an annuity – with many options available to retirees, you need to do your homework before settling on an annuity that’s best geared towards your unique circumstances. So let’s start to clear the fog by taking a closer look at the pros and cons of some of the annuities available to retirees.
Guaranteed annuity
What is it?
Also known as a life annuity, a guaranteed annuity is an insurance-type product. It guarantees to provide you with a predetermined income for the rest of your life.
Who provides it?
A guaranteed annuity can be purchased via a life assurance company.
What other annuities fall under the guaranteed annuity umbrella?
Conventional or level annuity: Offers a guaranteed income that remains the same until you die, but level annuities aren’t linked to inflation. So your income will be high at first, but this will soon lose its appeal when inflation kicks in, reducing your buying power.
Inflation-linked annuity: Even though your initial income is much less than you would have received from a level annuity, an inflation-linked annuity offers a guaranteed annual income increase linked to inflation. The increase is determined using a measure of inflation, such as the CPI index. A cap or limit is also in place, and some insurers might not pay inflationary increases if it goes over the cap.
With-profit or hybrid annuity: Also offers a guaranteed income for life. However, your annual income will increase depending on the portfolio’s investment returns. And if the returns are negative, your guaranteed income will stay the same (it won’t decrease). Your income will only increase based on how the investment performs, placing investment-risk in your court.
What are the pros?
- A guaranteed annuity insures you against the risk of depleting your money too soon due to poor investment returns and the risk that you live longer than expected.
- You’ll receive an income until you pass away.
What are the cons?
- When you die, your policy expires. This means any remaining capital won’t get passed onto your heirs.
- You can’t specify the initial income you receive, change your income or move to another annuity or service provider once you bought a guaranteed annuity product.
What are the exceptions?
You can opt for a guaranteed period of payment, where you can specify the number of years you’d like to receive a payout, or purchase a spousal/joint survivor benefit. However, more insurance or guarantee means less money every month.
What are the realities?
- You’ll get taxed on the income you receive as per the income tax table.
Living annuity
What is it?
As opposed to guaranteed annuities, a living annuity is an investment-type product.
How does it work?
You can decide on the level of income you want to receive every year. This amount should live within 2.5% and 17.5% of the investment value. However, once you’ve reached the 17.5% cap, then you cannot increase further the keep up with inflation.
What are the pros?
- More control. You can decide where to invest your money. You can opt for a higher income at first (if you still have dependents) and reduce it later (if your dependents become independent).
- When you pass away, your heirs will inherit any remaining capital.
What are the cons?
- Investment risk: Poor market performance will influence your investment. You might not get the returns you need (and when you need them).
- Outliving your money. This can happen by either by receiving a too high income early on, or living longer than you expected.
What are the realities?
- You’ll get taxed on the income you receive as per the income tax table.
Remember – you have the option of switching from a living annuity to a guaranteed annuity, but you cannot switch from a guaranteed annuity to a living annuity.
Retire blog
Saving for retirement is the biggest investment most of us will ever make. Sadly, it can also be very complicated. In this monthly blog, we try to answer some of the retirement questions we hear most often, ranging from which products are best suited to different circumstances to efficient tax treatments. Words by Carina Jooste.
