When you retire, two-thirds of your retirement fund savings must be used to buy what is known as a compulsory annuity (pension), provided by a life insurance company. What you do with the other third – and any other savings you may have accumulated in discretionary investments – is up to you.
If you need that money to supplement the pension you receive from your compulsory annuity, there are various ways to invest it – from RSA Retail Savings Bonds, to bank fixed deposits, to unit trusts and exchange traded funds. But life insurers are offering an increasingly diverse and sophisticated range of products designed to provide an income that keeps pace with inflation, and also protects against loss of capital and against longevity risk, where you outlive your investment.
These products were the focus of Glacier by Sanlam’s Life Investments Summit 2022, held recently. One of the key messages of the summit was that the products can be uniquely combined to suit your specific circumstances and objectives.
There is a relatively limited range of annuity products you can buy with your two-thirds compulsory, retirement-fund money. However, with voluntary, or optional savings, there is a broader range of products, which can be combined in different ways. They fall into two groups:
1. Voluntary annuities: The two main forms of annuity are a life annuity (you buy a guaranteed income for life with a lump-sum investment, with no choice in the underlying investments) and a living annuity (you use your lump sum to invest in your choice of underlying funds, your income being the return on those investments). There are many variations on these two basic types, including with-profit annuities (a life annuity with annual increases dependent on investment profits), flexi-annuities (which combine a life and a living annuity), term annuities (which are for a set term, instead of for life), and the recently launched optional Sanlam Income with Capital Preservation Plan (SICP), a life annuity combined with a life policy that pays out a predetermined lump sum on the death of the annuitant.
2. Endowments: These are policies operated by life insurers that may be used for a number of purposes. Among products in this category are those in which the underlying investments have been selected with retirement income in mind. One condition of endowments is that you have limited access to your money in the first five years.
Two business development managers at Glacier, Neal Sinclair and Rocco Carr, showed how these products, or combinations of them, can be used with great effect for clients.
Sinclair gave the example of Sarah, aged 50, who receives R3 million in a divorce settlement and needs it to provide an income of R20 000 a month, increasing at 5% a year, for 10 years before she begins to receive a pension of R14 000 a month at age 60. Sinclair says the R3m can be split into two annuity products: R1.6m into a 10-year term annuity and R1.4m into an optional SICP. The term annuity will provide a starting income of approximately R15 000 a month, ending after 10 years, when her pension kicks in. The SICP will provide a starting income of approximately R5 000 a month, and will continue for the rest of Sarah's life, with the capital preserved for her children on her death. (The incomes quoted are based on the available rates as at April 6, 2022.)
Carr said retirees want stability when it comes to income and returns. "Longevity creates a necessity for more exposure to growth assets, but many retirees cannot tolerate that volatility,” he said.
He singled out the Glacier Invest Real Income and Real Growth Solutions, which offer high levels of exposure to growth assets – but with lower volatility. The Real Income Solutions are available via retirement products and the Real Growth Solutions are available via the endowment or sinking fund solutions (both life insurance policies in terms of the Insurance Act). Combining a Real Income Solution with guaranteed products (such as a life annuity) could help achieve a sustainable income with low volatility.
The Glacier Invest 5% Real Income Solution, which targets inflation plus 5%, invests in a range of underlying funds, including balanced funds, hedge funds and a smooth-growth fund. While basically a moderate-aggressive risk portfolio, which one needs to combat longevity risk, it also offers protection against downside risk in the form of the hedge fund and smooth-growth fund exposure. Comparing the portfolio’s performance with other investments over the last five years, Carr said it achieved an average annual return of 9.5% at a lower risk than your average low-equity balanced fund (typically found in a living annuity portfolio), which returned only 7%.
At the summit, Diane Seccombe, head of taxation at the Mazars Academy, outlined the tax treatment of the various products discussed. Here are a few salient points.
Like compulsory annuities, the income they provide is classified as “remuneration”, and the life company deducts income tax as PAYE.
They are subject to the Section 10A tax exemption under the Income Tax Act, if the legislative requirements are met. This exempts you from paying tax on the capital portion of each income payment.
You do not pay income tax on the regular withdrawals after the initial five-year restricted period. However, the life company pays 30% tax on interest earned and 12% capital gains tax.
If your average income tax rate (not to be confused with your marginal rate) is more than 30%, you score tax-wise using these products.
Even if your average income tax rate is less than 30%, endowments may be beneficial for other reasons – for example, on death they can pay out directly to beneficiaries, which means there are no executor fees payable and the payout is not dependent on the winding up of the deceased estate. Another great benefit is the possibility of creditor protection after the first three years.