CIARAN RYAN: For many people, the biggest financial decision they face when they retire is how best to use their accumulated retirement savings to provide sustainable retirement income. Now, retirement is a complex event and it can be overwhelming for many people. Making the wrong choice about retirement can literally mean the difference between living in comfort or having to continue working past retirement age.
Fareeya Adam, Head of Retail Product Solutions at Momentum Investments, joins us to help clarify some of the retirement issues.
Hi Fareya. Thanks for join us. Traditionally, people have the choice between a life annuity and a life annuity, each with its own characteristics and rules. So maybe just explain what it is for those of our listeners who don’t know, and the benefits of each. Let’s start perhaps with the life annuity.
FAREYA ADAM: Sure. Hello everyone. With a life annuity, the main theme is flexibility. The client can choose investment components according to his investment strategy and he can adapt his income. The regulations require a client to choose an income level between 2.5% and 17.5% of the value of the investment. But this can be adjusted every year.
Now, one of the main consequences of a life annuity is that the client generally assumes all the risk. For example, if the markets are not progressing as expected and inflation is higher than expected, there is a risk that the income a client can withdraw will start to decline in real terms. Money must also last a person’s lifetime. So if you can’t find the right balance between living and living expenses, or if you’re one of those people who live very long, you may run out of money to pay for even the bare necessities.
Now, the risks of investment and inflation, as well as medical advances that allow people to live longer, are truly beyond our individual control. Thus, clients who choose a life annuity often believe that the main risk is dying earlier than expected, in which case they want to be sure that they can leave money for their beneficiaries. Indeed, the remaining capital of a life annuity is paid to the beneficiaries upon the death of a client.
But what people often underestimate is the risk of negative inheritance. So if a client lives longer than expected and runs out of money, instead of leaving a legacy to [their] dependents, which is often highlighted as one of the main advantages of a life annuity, [they] actually become dependent on [their] family members and it becomes a negative legacy.
CIARAN RYAN: OK. Let’s talk about the life annuity. It’s interesting. For people with a life annuity, living too long can lead to a negative legacy. Is it the same with a life annuity?
FAREYA ADAM: Not at all. The life annuity pays a guaranteed income for life, so it really matches a client’s basic expenses very well. The client is not exposed to market volatility or the risk of living longer than expected, as the income is paid for life. These risks are actually all borne by the insurance company, and a life annuity is the purest form of income protection because there is no risk to the client. It can be customized to some degree by adding a level of income increases, adding a guaranteed duration, or choosing to use a joint living option. But on the other hand, it doesn’t have the flexibility that we were talking about with the life annuity. Some people need this flexibility to deal with more variable living expenses. As a general rule, there is no capital available at death to ensure an inheritance.
CIARAN RYAN: I guess it’s worth remembering that each person will have somewhat different needs and different goals. So retirement planning is a very personalized thing, and you talked about that.
What we also know is that South Africans are poor savers and often only begin to grapple with retirement savings as they approach retirement age, often in the fifties. What are the different needs that people should anticipate?
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FAREYA ADAM: Certainly, as you say, a poor savings culture – along with the impact of poor investment behavior or investment returns – is certainly a real risk for retirees. At Momentum, we believe advisors and clients should really think about how to match a client’s expenses in retirement.
Now, there are different categories of expenses. First, there’s your base living expenses which include things like having accommodation, medical aid, groceries – really your regular essential expenses that you can’t live without. Then there are the living expenses, which are the things we all love to do, like paying for a vacation, starting a small business, contributing to a life event. But these living expenses must always come after your living expenses.
The third need is really the need to leave a legacy. It’s often very present, this need to leave a legacy, but it really should come after a client has covered the rest of [their] expenses. Now, the relative importance of these needs is a function of the amount a client has saved before retirement. Savings can be either inside a retirement savings product or outside through the accumulation of other assets. But that’s the real need of a retired client.
Today, a life annuity is generally better suited to cover a client’s living expenses, those that [they] can’t afford not to have money for. The growth assets typically included in a life annuity align well with a client’s living expenses and the need to leave a legacy.
CIARAN RYAN: Alright, let’s finish this together. Even if people decide to use part of their retirement savings to purchase a life annuity and part to invest in a life annuity, they may end up with two separate retirement income products, making it difficult to manage their retirement income. Is there a solution to this?
FAREYA ADAM: More often than not, people just choose one or the other. In most cases, the risk-sharing decision is made at retirement, so it becomes a one-time decision that affects the client’s income for the rest of their life. [their] life.
Now, those who have split their retirement savings between a life annuity and a life annuity usually have to set up two contracts, which tends to be a cumbersome process. We don’t see that happen very often.
But Momentum Wealth recently redesigned our life annuity solution, called the “retirement income option.” An advisor can now include a guaranteed income inside the life annuity as one of the components of the investment. [The advisor] achieves this by investing a portion of the assets in our new guaranteed annuity portfolio.
So you can always personalize the income by choosing annual income increases to protect the real value of the client’s income and reduce [their] inflation risk. And you can also partially meet the need for an inheritance by incorporating warranty terms and joint living options, but that’s a protected part inside your life annuity. The remaining life annuity assets can then continue to be invested in a variety of investment components to increase capital value and provide greater income flexibility. The bigger it grows, the more opportunities a client will have to earn income and leave a legacy.
So effectively what we offer is growth and income protection in one solution – the balance between the two being up to each individual.
Moreover, a client and an advisor do not have to make this decision only in retirement.
With the Momentum solution, they can choose when to protect part of the income and how much they want to protect at any time during the client’s retirement.
CIARAN RYAN: All right, Fareeya, here’s one last question. Where can people go to get more information about your new solution at Momentum?
FAREYA ADAM: The best place to go is our website www.momentum.co.za and look for the reimagined retirement banners.
CIARAN RYAN: Fareeya Adam, Head of Retail Product Solutions at Momentum Investments, thank you very much for your time.
FAREYA ADAM: Thank you for hosting me.
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