Choosing between a Life Annuity or a Living Annuity?: Part 1
Managing Director for Corporate Segment, Old Mutual Namibia.
Those of you who are nearing retirement age have most probably thought about life after work and most importantly how to sustain yourselves when there is no longer a monthly salary coming your way.
Some of you participate in your employer’s Pension Fund Scheme specifically for the time when you need to step out of formal employment. The question now remains: what to do with the pension fund savings built up over the span of your working life? In terms of Income Tax Act No.24 of 1981, you will have to buy an annuity with at least two-thirds of your pension fund savings when you belong to a pension fund and if your savings are more than N$50 000.00. One-third of your pension savings will be paid out to you as a tax-free lump sum, should you choose so.
An Annuity is simply defined as a sum of money paid regularly by a financial institution at a certain time in the future, to a person. This can either be for the remainder of their life or for a limited number of years, depending on the type of annuity purchased.
Life is never a static journey. It is about taking decisions every step of the way – certain decisions are good while others can be pretty bad, but we have to navigate life. Well-informed decisions usually make us feel a bit more comfortable steering through the uncertainty of the future.
It is therefore vital to gather as much information as possible in order to make the best decision to enable you to enjoy the retirement you deserve. The real retirement journey starts on the day you stop working – and the decisions you make about where to invest the money you have saved over the years will impact the type of retirement you get to experience.
As indicated earlier, two-thirds of your pension savings will have to be used to buy an annuity, and you have a choice of either a Life Annuity or a Living Annuity.
Let us have a look at the different possibilities under each of the two types of annuities available in the market, to empower you to make the best possible decision for your retirement:
With a Life Annuity, the payment of pension is guaranteed for life and paid in monthly installments to the pensioner.
The pensioner can choose to purchase a guarantee period (five or ten years or more), this means the term is certain. The full pension will continue to be paid for the duration of the guaranteed period – even if the pensioner dies before the end of the guaranteed period. This is usually a good option should the pensioner want to leave some capital to his/her beneficiaries after death.
The Life Annuity further provides for different possibilities, and an annual pension increase will depend on the type of life annuity purchased by the pensioner:
Level Annuity: the insurer takes the pension savings at the date of retirement in exchange for a regular level monthly payment (no increases) made to the pensioner. Payments are guaranteed for the life of the pensioner;
Escalating Annuity: To cover the increasing costs of living, escalating annuities should be considered. The Insurer takes the pension savings at the date of retirement, and in return will pay monthly pension payments. These payments will however increase each year. There are various increase options available;
With-Profit Annuity: The monthly pension creases each year at a rate that is linked to After Retirement Interest (ARI) that is assumed and the performance of the underlying investment portfolio.
Further elections to a Life Annuity can be bought. The pensioner can ‘buy’ the guaranteed income for the pensioner only (Single Life Annuity) or for the pensioner plus the pensioner’s spouse/partner (Joint Life Annuity):
Single Life Annuity: The monthly pension payments stop when the pensioner passes away and no money will be available to beneficiaries;
Joint Life Annuity: Pensioner’s spouse/partner will continue to receive pension payments for their life, after the death of a pensioner, if the pensioner dies before his/her spouse/partner passes away.
The initial pension is determined by the insurer based on the age and gender of the pensioner plus all the factors mentioned above such as – type of increase purchased, guarantee period purchased, single life, or joint life. The more options are chosen, the lower the initial monthly pension will be.
Once the pensioner and his spouse (for a joint life annuity) pass away and the guarantee period has ended, the remaining retirement capital remains with the insurer and is used to cover the cost of annuities of those pensioners that are living longer than anticipated. This annuity option is usually for persons who do not need a big lump sum payment for a specific purpose, but rather need a stable and predictable income. The decision power is really based on your needs at retirement.
With a Living Annuity, there are no pension payment guarantees. There is no insurance contract, but rather a pure investment contract. The pension savings from the retirement fund is invested with the insurer. The choice of investments used is up to the pensioner. The money is invested in a portfolio chosen by the pensioner. It further provides flexibility to the pensioner in terms of drawdowns – ranging between 5% and 20% of the capital as income each year.
The remaining capital in the investment is available to the beneficiaries of the pensioner once he/she passes away.
The journeys of the Life and Living Annuities are very different – it might therefore be wise to source the services of a Financial Adviser to assist in selecting the correct option or even a combination of a Life and Living Annuity.