Eric asks: Am I correct in understanding that an RA will guarantee a living allowance for the first 10 years of your retirement, but should you pass away on the 11th year the remaining capital of that RA will revert back to the insurance company?
Maya replies: Just for clarity, an RA, or retirement annuity, is usually the terminology used for the accumulation of retirement funds — in other words you save into a retirement annuity while you are working.
When you retire from the fund, two-thirds of the retirement annuity must be used to purchase an annuity, which will pay you an income in retirement.
With a fixed annuity (or life annuity) your lump sum buys you a set income. It all depends on the type of annuity you purchase as to when it will stop paying out.
The two most common are a single life annuity and a joint life annuity. A single life annuity will pay you an income for as long as you live. So if you die in the second year, the life company retains the money but if you live to 100, they have to keep paying.
With a joint life annuity you can insure your spouse, so if either of you die the other will still receive the income.
Life companies will offer variations of these with different guarantees, and these vary from company to company, so it is worth finding out exactly what you are buying.
Below are definitions from Alexander Forbes of some of the most common options:
Fixed annuity
Increases: No annual increase. However, you have an option to choose a flat annual increase e.g. 3%, 5% or 10%, this will reduce the initial income you receive.
Pension is paid for as long as you are alive.
Advantages: If no annual increase is chosen, the initial pension is higher. The pension is paid for
life. Your spouse will receive a pension when you pass away*.
Disadvantages: Income doesn’t increase unless chosen — therefore doesn’t keep up with inflation.
You are not able to adjust your income level as time goes by.
With-profit annuity
Increases: The insurance company decides on annual increases — depending on investment performance.
Pension is paid for as long as you are alive.
Advantages: Initial pension and increases declared by insurer are guaranteed for life.
Insurance company takes the risk of poor investment performance. The pension is paid for life. Your spouse will receive a pension when you pass away*.
Disadvantages: You have no say in where your money is invested. The pension increases can be low or even 0% if markets are performing badly.
Inflation-linked annuity
Increases: Increases are based on inflation during the year.
Pension is paid for as long as you are alive.
Advantages: Your income keeps up with inflation and is protected against increases in the cost of living. Your spouse will receive a pension when you pass away*.
Disadvantages: The pension increases can be low or even 0% if inflation is low or 0% respectively.
Living annuity
Increases: You decide on the level of income you need to get every year with a financial adviser (within 2,5% and 17,5% of the investment value).
Advantages: Flexibility. You decide where to invest your money and you choose your own income level.
Disadvantages: You carry the risk of poor market performance — no guarantees. There is a risk of outliving your money, that is the risk of you living much longer than expected and drawing too much income early on.
Alexander Forbes Lifestage annuity
Increases: You decide on the level of income you need to get every year with a financial adviser (within 2,5% and 17,5% of the investment value).
Advantages: Annual checks are done to see when it is best to annuitise — you have an option NOT to annuitise. Once annuitised there is no chance of you outliving your money as the pension is guaranteed for life and your spouse will receive a pension when you pass away*.
Disadvantages: Before you annuitise you carry the risk of poor performance — there are no guarantees. If you choose not to annuitise you run the risk of outliving your money, similar to the living annuity above. After you annuitise, there is no money left for your children to inherit.
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