By Freddy Mwabi, Actuarial Specialist
Just how attractive will such an in-fund living annuity be for the average worker? This will be particularly relevant if compulsory annuitisation of retirement beneﬁts in respect of provident funds becomes effective on 1 March 2018.
In late 2016, National Treasury published its second draft of the proposed retirement fund default regulations. One of the requirements is that the rules of pension, provident and retirement annuity funds make provision for an annuity strategy. Living annuities may be offered in terms of the annuity strategy. However, preference is to be given to in-fund living annuities, as they could offer much-improved cost efﬁciencies, seamless transition and the potential to give members a better retirement outcome than out-of-fund living annuities.
The trustees are in a position to offer in-fund living annuities to their members at very competitive prices. In addition, when a member selects an in-fund strategy, there would typically be no additional administration fees or commissions. If the member chooses to make use of the services of a ﬁnancial adviser, any advice fees can be paid from the beneﬁt, if arranged.
On the other hand, should a retail living annuity be chosen, it may attract up-front administration fees and commissions. Ongoing platform and advice trail fees are also likely to be payable.
Consider the case of a member who has accumulated R1 million at retirement and is faced with a choice of an in-fund living annuity or a retail living annuity. We assume the member chooses an initial drawdown rate of 7% (the average drawdown rate in South Africa according to research by ASISA) and a conservative annual increase of 50% of inﬂation. We also make the following assumptions regarding costs and investment returns:
The result of the costs, annuity drawn and fund value projections are as follows after 10 and 20 years, respectively:
From the results of the calculations we can observe that due to higher costs, the fund value in the out-of-fund living annuity is 79% of the fund value in the in-fund annuity after 10 years. This ﬁgure drops further to 50% after 20 years.
The difference in costs also affects the income drawn from the annuity, as illustrated by the graph below:
In this scenario, the initial drawdown amount in both funds increases at the same pace (50% of CPI) for the ﬁrst 14 years. Subsequently, the annuity provided by the out-of-fund living annuity starts to decline as the fund value decreases to the extent that the required annual drawdown is greater than the maximum allowable 17.5% of assets. Therefore, the member can only draw up to 17.5% of a decreasing pot each year. In comparison, the in- fund living annuity reaches the drawdown ceiling approximately 5 years later. Over 20 years, the in-fund living annuity provides a greater total annuity drawdown as shown in Table 2. Furthermore, the drawdown provided by the out-of-fund annuity is approximately 50% of the income drawn from the in-fund annuity after 20 years.
Most workers require a certain amount in a cash lump sum when they retire, to prepare for and adjust to the next phase of their lives. But what do they do with the rest of their retirement beneﬁt? They plan to invest it in some way to secure an income – right? What the research tells us, is that the smart money will remain in the fund and will select the in-fund living annuity. Based on our research, a member is not likely to ﬁnd a better combination of cost efﬁciency, ﬂexibility and convenience in an annuity anywhere else in South Africa.
In this example, an efficiently priced in-fund annuity will offer the member 14% more in pension payouts over 20 years (R1 795 000 vs R1 574 000 in Table 2) than a typical out-of-fund alternative, leaving the member with double the assets (R541 000 vs R269 000, also in Table 2).
Disclaimer: This publication provides information and opinions of a general nature. It does not constitute advice and no part thereof should be relied upon without seeking appropriate professional advice.