Liberty Life has launched an innovative living annuity with a guarantee against market losses, which it hopes will enable retirees to take more investment risk and achieve more growth on their capital.
The Bold Living Annuity offers a five-year renewable guarantee on the returns from your chosen portfolio of funds. On the day you take out the guarantee, it guarantees against a market loss of 20 percent on your capital and the income you draw from it.
The guarantee against the 20 percent drop in your capital is not static. It moves up each quarter to protect you against such a drop in your cumulative capital and returns earned from the outset, known as your high-water mark, and you are guaranteed 80 percent of this amount.
So, for example, when your aggregate return reaches 25 percent, the 80 percent high-water mark will have risen to the level of your entire initial capital – in other words, the guarantee at that stage ensures no loss on the initial amount you invested (a 20-percent loss on 125 percent = 100 percent), David Lloyd, managing director of Liberty Innovate, explains.
Once you have reached the 25-percent aggregate return, the new high-water mark ensures you can’t experience an average negative return on either your income withdrawals during the five-year term or on your capital at the end of the term.
This means you can invest your capital a lot more aggressively than you would otherwise typically do in a living annuity (see “The living annuity conundrum”, below).
The guarantee is accessible when your living annuity is created on the Stanlib investment platform and you can use it in conjunction with any of the more than 160 unit trust funds listed on that platform from a variety of asset managers, as well as the 30 Liberty portfolios offered on that platform, Lloyd says.
There are no restrictions on the funds you can invest in or the switches between funds that you can make, he says.
If, for example, you invest R1 million in a living annuity that invests in underlying unit trust funds so that one unit of the portfolio costs R1 000, your R1 million will buy 1 000 units.
If you want to draw an income of R10 000 a month, you will have to sell 10 units a month or 120 units a year: an income drawdown of 12 percent.
If you take the guarantee, Liberty guarantees you will always get at least 80 percent of the unit cost, or R800 for each unit sold.
If the market drops and your unit value falls to R900, you will have to sell more units (11.11) to maintain your R10 000 income.
But if your unit value falls to R750, a 25-percent loss, you would ordinarily have to sell 13.33 units to get an income of R10 000. With the guarantee in place, however, you will only have to sell at most 12.5 units and Liberty will ensure that you receive your monthly income of R10 000.
If the market increases the value of a unit, from, for example, R1 000 to R1 200 at the end of the third month, the guaranteed unit value will move up from R800 to R960 and will never go below that amount, regardless of the losses incurred on the portfolio.
It will move up again when, at the end of any subsequent quarter, the portfolio reaches a new high.
If you experience a really bad five-year period and at the end of it your capital is more than 20 percent below your initial capital, Liberty will top up your capital to 80 percent of what you initially invested.
Lloyd says portfolio guarantees are expensive, but Liberty has set the guarantee costs at a once-off one percent of your capital invested (which works out to about 0.17 percent a year, allowing for compounding over the five years).
Further charges apply each year only if the growth on your living annuity capital is very good and exceeds an annual return above a certain level. Currently, that level is set at 14 percent for the five years and Lloyd says it will be reviewed in line with inflation expectations for each new five-year guarantee period.
At that point, you will pay an annual fee of 20 percent of the return that exceeds 14 percent. So, for example, if you earn 15 percent, you will pay 20 percent of one percent, or 0.2 percent for that year for the guarantee, Lloyd says. Liberty calls this growth-sharing.
The guarantee is optional and can be cancelled at any time, which you may want to consider if the market is doing well and is expected to continue to do so.
You can either restart or roll over the guarantee after five years, by paying the one-percent initial fee again and the 20 percent fee on any growth above a set level.
Agile investment
A year ago, Liberty launched its Agile Retirement Annuity (RA) and two preservation funds on the Stanlib platform. The Agile funds allow you to use some of your savings to secure an income in retirement many years before retirement.
This is achieved by allocating some or all of your savings inthe Agile funds to the Exact Income Fund, which guarantees a particular income, or pension when you retire.
The Agile products were intended to overcome the problem of saving towards a lump sum at retirement without being sure what retirement income that lump sum will provide. This is because the rate for the pension you can buy changes over time, as does the cost of investing in a portfolio that will generate the income you need.
The Agile range’s Exact Income Fund operates like a deferred annuity, but gives you the flexibility to choose a different annuity at retirement.
Lloyd says the Agile RA or preservation funds can be used together with the Bold Living Annuity. A portion of the Agile RA can be used to provide a guaranteed income at an older age, such as 85. The remainder of your savings at retirement are placed in the living annuity, enabling you to generate as much income as possible for your younger retirement years.
THE LIVING ANNUITY CONUNDRUM
Living annuities are the most popular choice of annuities in South Africa, but they are also typically a risky choice, because you have to draw an income from your capital, which is invested in the financial markets and therefore subject to fluctuations in value in line with the movements of those markets.
The Income Tax Act obliges retirees with living annuities to draw an income of between 2.5 percent and 17.5 percent of the capital in a living annuity each year.
Research by local and international companies has determined that a safe income level to draw is around four percent. The Association of Savings & Investment SA (Asisa) has determined safe withdrawal levels for different age groups.
The average withdrawal rate, is, however, typically higher than recommended levels, at around 6.4 percent, according to Asisa.
At the beginning of the year, you may decide on a level at which to draw an income from your annuity – for example, four percent. But if the markets fall sharply during the year, the rand amount you are withdrawing may suddenly increase to, for example, six percent of your capital.
If your capital does not recover quickly and you continue to draw down the same rand amount, the percentage of your capital you are withdrawing as an income will increase each year until you hit the maximum withdrawal level of 17.5 percent a year.
When that happens, you will be forced to withdraw an income that diminishes in rand terms each year.
The alternative to a living annuity is a guaranteed annuity. This guarantees an income in retirement for the rest of your life, regardless of how long you live. Many people are reluctant to take out guaranteed annuities because when you die the remaining capital reverts to the life assurance company.
There are ways to mitigate the risk of your heirs losing the capital, by taking out a guarantee on the income for the first 10 years, for example.
Alternatively, some financial institutions recommend taking out life cover to provide for your heirs.