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How do you decide between retirement income options in the retail market? Part 3

With a hybrid annuity option, you can have your cake and eat it too.

Now that we’ve drawn a comparison between living (investment-linked) annuities and life (guaranteed) annuities in Part 1 and Part 2 of this series of articles, we can elaborate on the hybrid annuity option.

I concluded in Part 2 that you don’t have to choose between the benefits of either a living annuity or a life annuity, but that you can strike a balance between guaranteeing an income for the rest of your life, and having more flexibility in terms of the income itself and the underlying investment portfolio of your annuity, as well as leaving an inheritance for your beneficiaries.

Combining the options

Firstly, you can combine these two options by buying two separate annuities, i.e., investing a portion of the available pension benefit in a living annuity, and buying a life annuity with the balance.

When doing this, an advisor would usually try to cover your absolute necessary expenses from the life annuity income, and then cover the rest from the living annuity income.

Another option is to invest in a hybrid or blended annuity, offering you the opportunity to have your cake and eat it too, in one investment product.

The hybrid option

More and more service providers offer a hybrid/blended option. Blending offers the ability to partially annuitise inside the living annuity. You can balance the various trade-offs by switching additional tranches into the guaranteed life annuity component when you need to, and build an optimal portfolio over time.

Just Retirement, a provider of hybrid annuities, summarised the benefits as follows:

Again, looking at these benefits, it would greatly depend on each individual’s personal circumstances as to how they would go about combining the two types of annuities.

As I’ve mentioned, usually the non-negotiable expenses should be covered by the guaranteed annuity, where the more variable expenses can then be covered by the income from the living annuity.

Let’s look at Sue Smith again, from the example in Part 2: She still has R1 million to invest, to provide her with a monthly income, but in this scenario, she invests in a hybrid annuity – with R700 000 allocated to the guaranteed portion to cover her core expenses, and R300 000 allocated to the living annuity portion:

  Hybrid Annuity
  Guaranteed annuity Living annuity Total  
Capital R700 000 R300 000 R1 000 000  
Income drawdown 7.35% 5.00%  
Monthly income amount R4 287 R1 250 R5 537  

As I want to highlight again, you will be allowed to convert portions of your living annuity to the guaranteed life annuity at any point in time. This can be helpful to ensure provision for increased expenses later in life. It is however important to note that once you move any amount of capital from a living annuity to a life annuity, you can never switch it back to a living annuity. This is the case whether you manage the balance between the two options manually, or whether you invest in a blended annuity.

Conclusion

For every individual, different combinations of all the variables will apply, such as whether you add your spouse as an additional life assured on the policy, whether you take a guarantee period or not, whether you take an increasing or level income, etc. These will all have a material effect on the income provided by the guaranteed portion of the annuity.

The living annuity portion will still function the same as any other separate living annuity, where all the same rules apply, such as the limits to the annual drawdown (2.5% – 17.5% per year, where the percentage and regularity of the income can be amended once a year), the fact that you may not withdraw ad-hoc amounts from the capital, and being able to leave an inheritance for your beneficiaries.

Furthermore, it is always important to keep a balance between your compulsory investments (retirement products) and your discretionary money. You can also further supplement your retirement income from a discretionary investment portfolio. More on this topic in my next article.

If you are at a point in your life where you need to consider various options for retirement income, please get in touch with us. It is your freedom to shape your future.

Structured Products

Structured Products

Structured products: build in downside protection Structured products are pre-packaged fixed-term investments that provide private investors with easy access to offshore equity and commodity markets, with a pre-defined risk and return profile over a pre-defined...