Question:
When deciding on what type of monthly pension to take, to what extent does one's life expectancy matter regarding 1) a living annuity and 2) a conventional life annuity?

Is a flat or escalating pension better as there are years when the fund does not pay an increase?

Answer:
A person’s life expectancy is critical in the planning of their finances, regardless of the financial product in question. Life expectancy is not a date that can be diarised and planned back from, but is rather a very roughly thought-out gut feel that one could get rather philosophical about. That aside, it does pose some important considerations when choosing where to place your hard earned retirement savings.

Considering that all money originating from retirement funds (i.e. pension funds, provident funds and retirement annuities) must be placed into either a living annuity, a conventional life annuity or a combination thereof, it would be prudent to first explore the nature and make up of these two vehicles, as well as potential risks, before deciding on which one may be right for you.

An Individual Living Annuity (ILA) is a retirement fund a retiring member can transfer to with the opportunity to invest in underlying asset classes through various fund choices while drawing an income of between 2.5 percent and 17.5 percent of the fund value annually. This income can usually be paid in monthly or quarterly instalments and can be adjusted up or down (within the bands) as needed upon contract anniversary.

Depending on whether the funds originated from a pension or provident fund, Regulation 28 of the Pensions Fund Act stipulates the Prudential Investment Guidelines (PIGS) that do not allow an equity exposure greater than 75 percent in the portfolio. Other than that, one can invest according to your required drawdown needs and essentially 'manage' how long this money will last.

One of the greatest risks with the living annuity is that if one draws down too aggressively, one may find yourself with life at the end of your money. In other words, much like how a bank account would work, once the money is gone — it’s gone. However, people with larger retirement funds and low drawdown requirements may well find themselves in a position of leaving whatever funds are left in the Living Annuity to their heirs and dependants.

A conventional life annuity works quite differently in that one would approach the investment company (usually a life assurer) with one’s retirement amount. Then, according to your age and gender, they will quote an income amount that they will pay you until the day you die. Of course, the younger you are, the longer you are expected to live and the lower the income offered. Naturally, if one decides to retire at an older age, one could expect a higher income amount due to a shorter income paying period by the assurer.

The gender split is done purely because actuarially, women live longer than men and therefore impose a higher 'risk' to the assurer from an 'extended' income period.

So although this type of annuity provides an immense amount of certainty and security around one’s retirement income, it does come at a cost. Firstly, one should carefully consider the income offered as a percentage of assets and question whether prudent investing may offer better returns (different ages will determine different results).

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