Retirement Annuities play a vital role when one decides to finally put down the tools for the last time. It means that you won’t be earning any salary but/maybe pension income.
A retirement annuity will make your finances to be solid as a rock during retirement. As much as retirement annuities come with many benefits, they also have their own setbacks.
However, annuities can provide a comfortable lifestyle after retirement, that is if your investment was designed to finance your lifestyle needs.
In most cases in South Africa, companies advise their employees to invest in retirement annuities. But the question is, how do you get to choose the right retirement annuity for yourself?
Some companies answer this question by simply deducting a certain percentage from your gross income to invest in annuities. This approach, however, comes with its own problems. There is a never one size fit all in investing.
Sometimes investing on your own can help you tremendously instead of having your money invested by your employer, in a retirement fund that will benefit you less. In fact, retirement annuities are made to cater to the individual needs of an investor, hence, it is nearly impossible not to invest properly for your retirement when you use them.
What is a retirement annuity?
Before going any further, we need to understand what retirement annuities are. Retirement annuities are retirement savings held by an insurer with a promise of paying the money back with interest at a certain future date.
For a retirement annuity to start, there has to be a contract whereby an individual agrees to contribute an agreed-upon amount either as a lump sum or fixed contributions or variable contributions.
The retirement income is the money that an individual and an insurer agree upon and will be paid to the annuity user within an agreed time frame. This money can be paid in a lump sum or in a series of regular payments. In South Africa, retirement annuities can be claimed from the age of 55 to 65 years, depending on the insurer you use.
How retirement annuities work
An individual needs to contribute a sum of money, be upfront or in different payments over time, this depends on the annuity provider you will choose and the terms of the agreement. The insurer will then have to promise to pay you (investor) regular or once off payment(s) with interest.
An insurer normally asks an individual investor how much they want to earn upon retirement. The answer is to normally match retirement income with the annuity user’s current monthly income.
By making a choice of how much you want to make at retirement, which is any time after you reach 55 years, the insurer will give you a quote on how much you need to pay as a lump sum or on a monthly basis to achieve your goal.
If you don’t agree with the monthly or once-off contribution(s) you can either opt for a reduction or an increase in contribution(s). Should you reach an agreement, the agreement will be valid until maturity. Hence, you need to know what type of retirement annuity you are taking.
Normally you will need to choose between an income and deferred annuity. The difference is that income annuity starts paying off immediately normally a month or year after placing an initial investment and requires a lump sum investment, on the other hand, deferred annuity begins payments at a future date.
The difference between a fixed and variable annuity is that for a fixed annuity the insurer pays a specified rate which is guaranteed and for a variable annuity the insurer invests your money in a unit trust or subaccounts.
Should you be investing in retirement annuities?
Many people choose retirement annuities to secure their finances after retirement. This action is mainly done to supplement pension fund payouts since they don’t pay much. But do retirement annuities really work for you or do they work for the insurance companies?
The answer to the question is not simple, as retirement funds offer guarantees, meaning insurers assume liability. Furthermore, the fact that an annuity owner has to wait for a certain period to access funds means they might not directly benefit from premature death.
The answer lies in between, that is retirement annuities benefit both the insurer and the annuity owner.
Here are some of the advantages and disadvantages of retirement annuities.
Competitive Advantages of Retirement Annuities
- Comes with a guaranteed income in retirement.
- The contract has the ability to adapt to match the annuity owner’s needs over time.
- Can offer professional money management features such as periodic portfolio rebalancing.
- Uses a compound interest, making it much better than most investment opportunities out there.
- Can choose from either deferred or immediate annuity depending on your investment needs.
Competitive Disadvantages of Retirement annuities
- Annuity owners will need to pay income tax to SARS if they are below the age of 65.
- An annuity owner incurs charges if he/she gets out of a retirement annuity before maturity.
- Comes with annual maintenance fees and operational charges.
What you need to consider
It is important to understand what retirement annuities entail for your future. The best way to get a broader view of retirement annuities is to consult a reputable professional before purchasing one.
Annuity products are complex and are not a one size fits all, at the end of the day we all have different needs and dreams.
A professional consultant will advise you according to your needs and how you can get tax exemptions on annuities.
A retirement annuity is basically your financial assurance during retirement, so you may need to spend some money on consultation fees before making a mistake that you will live to regret.
Retirement Annuities are expensive to maintain, so you need to be working before you can apply to be part of one. Some retirement annuities start from as low as R500 per month, but your retirement income will surely not be as good as you may want it to be if you are to pay low instalments, even if inflation is considered.
A cost-free solution that you can use to differentiate between a bad retirement annuity and a good retirement annuity is the use of an inflation calculator and an annuity calculator. Use these tools to make sure that you are getting your money’s worth.