At Sam’s recent retirement party his boss led the speeches and wished him and his wife long and happy lives in retirement. Isn’t that what we all want for ourselves? But, how many of us consider how long we could live for and whether we have adequately provided financially for this?
Over recent years there has been increasing awareness that people are on average living longer than they did before. Notably, those who make it to retirement age are now living longer after that age than previously.
A look at current US population statistics – South Africa can expect to move towards the States in this respect – shows the life expectancies for people who survive until age 65, increases to 83 years for males and 86 years for females.
As such, on average a male needs to build up sufficient capital by retirement to support himself for a further 18 years. But, you need to remember that this statistic is only an average. In fact a quarter of the men who reach 65 are expected to live beyond age 89 and in turn, some of them for much longer.
Insuring against long life
You may be among the fortunate, who followed all the financial advice available to you over the years and you scrimped and saved for retirement and invested sensibly in long-term growth portfolios. When changing jobs you transferred your retirement fund withdrawal benefits to a preservation fund and your most recent benefit statement shows you are on track to achieve your targeted replacement ratio after retirement.
But, how do you ensure that this money will produce the level of income that you are expecting and will continue to produce this level of income no matter how long you live for?
The answer is a simple one. You take out insurance against living for too long. And that is exactly what a traditional guaranteed annuity provided by an insurance company does. It pools the risks associated with thousands of different retirees into a risk pool where no-one knows how long any one annuity will be paid for, but where the average is more predictable. Individual retirees can relax knowing that their pension will continue to be paid no matter how long they live for.
Ins and outs of guaranteed annuities
There are two risks to be conscious of in guaranteed annuities. The first is the balance sheet of the insurer. You need to be confident that the insurer will still be around in future decades.
The second is inflation risk, i.e. how well your annuity preserves its buying power in the future. The buying power of a level annuity will quickly decline, so including provision for increases that are expected to more or less keep up with inflation is important.
Keep in mind that the greater the certainty you want relative to inflation, the more you will have to pay upfront. As such, inflation-linked annuities are the most expensive, then fixed-increase annuities, while with-profits annuities are the cheapest.
Note also, that insurers will price guaranteed annuities based on what they expect to pay out in the future. The more they expect to pay in respect of an annuity contract the more they will charge, which reduces the starting income. So, do not include any features that you do not require as they will reduce what you get from the annuity. If you need them, then make sure that they are included.
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