Both a living annuity and a guaranteed or life annuity will provide you with a monthly income during your retirement. But whereas a living annuity is an investment product (your funds will continue to grow in the market while you draw down an adjustable monthly or annual amount), a guaranteed or life annuity is classed as an insurance product (you will receive a guaranteed monthly sum for life, irrespective of market movements).
Whereas living annuities have over the past 20 years been the go-to choice for most South African retirees, guaranteed or life annuities have increased in popularity of late, mainly due to the compelling rates most providers are offering. A major advantage of a life annuity is that you don’t run the risk of outliving your savings (the insurer carries this risk). However, this type of product does have one significant drawback – upon your death, your remaining capital will be retained by the insurer, and no funds will be passed on to your beneficiaries.
There is a way of securing a guaranteed income stream for a period of time while not eventually forfeiting your capital, however – locking in bond rates via a living annuity.
HOW DOES IT WORK?
When you buy a conventional guaranteed annuity, a life insurance company will offer you various rates for different options (for example, no annual increase, an increase of 5% per year, an inflationary increase, or various guaranteed scenarios). With this annuity, you’ll be certain of your expected monthly income, based on your quoted rate, which remains fixed.
The life insurance company will typically purchase long-dated individual government bonds with your retirement funds to match your desired income stream (also called your ‘liability’). It should be noted, however, that since annuity rates are directly linked to long-term bond rates, if you buy a life annuity when rates are low, your income, while guaranteed, will also be low.
For traditional living annuity products, you’ll complete a risk profile questionnaire and your funds will be invested in a portfolio consisting mainly of unit trusts. Unlike an individual bond, a unit trust has no maturity date – instead, it has what’s known as ‘perpetual duration’. For example, if your funds are invested in a bond unit trust, the latter will not mature – when one bond within the unit trust matures, another one is purchased with a duration determined by the mandate. The income generated from the investment is therefore uncertain.
The third option, of locking in bond rates within a living annuity, essentially replicates the investment strategy used by life insurance companies – matching your assets with your current and future liabilities. Here, the living annuity does not invest in bond unit trusts but in individual bonds, offering more certainty around returns and income production.
Purchasing government-guaranteed bonds provides a level of assurance that allows you to make decisions based on known returns rather than projected ones. But unlike a life annuity, a living annuity offers flexibility in terms of rates. If rates are low and unattractive relative to inflation, one may choose to wait until rates become more compelling.
Furthermore, any ‘surplus’ returns can be channelled towards other financial goals. For example, if you invest an amount of R10 million in a R2035 bond, the return is known to be 11.3% per annum until 2035. If you require an annual return of only 4.5% for your income needs, however, then you have what is referred to as a surplus. Roughly, only 50% of your assets would need to be used to purchase the R2035 to meet your liability of R450 000. The surplus can then be invested to achieve various objectives, such as inflation protection or mitigating sovereign risk.
WHY CHOOSE BONDS?
In a nutshell, bonds are a cornerstone of a conservative investment strategy, offering predictable returns and lower risk compared to equities. They provide regular interest payments, which can be a reliable source of income for retirees.
Bear in mind that an investment in bonds is not entirely risk-free – the capital value can fluctuate. Local bonds are linked to the performance of the South African government, so there will be some risk involved, albeit very low (this risk would be the same for both a life annuity and for locking in bond rates within a living annuity).
At Sanlam Private Wealth, we’ve curated a selection of bonds with varying maturities and competitive rates to suit your individual needs and investment horizons. Our team will customise a retirement solution for you to harness the best of both worlds – providing enough income to cover your daily living expenses while also ensuring your capital continues to grow.
We’ll work with you to understand your unique financial goals, and craft a personal solution to safeguard your income in retirement as well as leave a legacy for generations to come.
TAKE THE NEXT STEP
Investing in bonds can play an important role in your overall retirement strategy. To learn more about how our bond offerings can benefit you, please contact us:
Yash Raghavjee (CFA, CMT): YashenR@privatewealth.sanlam.co.za
Guy Allan (CFA, CAIA): GuyA@privatewealth.sanlam.co.za
