Monthly Archives: August 2016

A life annuity and a guaranteed annuity

unduhan-58The first thing to understand is that a ‘guaranteed annuity’ is not just one type of product. There is actually a range of different guaranteed annuity products, namely guaranteed escalation annuities, inflation-linked annuities, index-linked annuities and with-profit annuities.

Identifying which one is the right choice for you requires you to understand your current needs, your likely future needs, and the different benefits that each provides. This is best done with the help of a qualified financial planner who can analyse your requirements and match them to a product.

The one you choose will largely determine the starting pension for a specific lump sum, as each type of guarantee has a different ‘price’. You therefore have to think carefully about what you do and don’t need.

The other factors that will influence the size of the monthly pension you receive from your guaranteed annuity would be:

  • Interest rates (real rates or nominal rates)
  • The current level of the equity market (for index-linked or with-profit annuities)
  • Your age
  • Your sex
  • Expenses (initial upfront expenses, on-going expenses for administration)
  • Commission (to a maximum of 1.5%)
  • The additional features of your product, including whether you chose a guaranteed period, spouse pension, a death benefit and the choice of a thirteenth cheque every year.

With regards to your question on interest rates, these rates definitely influence the pricing. The higher the interest rate, the lower the pricing on a guaranteed annuity and visa versa.

At the time of purchase, therefore, the interest rate is important. Because higher interest rates will mean higher investment returns, the insurance company underwriting your annuity will be able to offer you more when interest rates are higher.

However, once you have purchased the annuity, any increases in your pension will depend on the type of product you choose. If you select a guaranteed escalation annuity, the increase will not be influenced by interest rates as the rate of increase is set from the start. Similarly, inflation-linked annuity increases are linked to published inflation by government, and so interest rates will play no part.

Only increases in index-linked annuities and with-profit annuities will be dependent on equity market returns and interest rates. Their increases are made in reference to how investments perform.

In deciding what is the best course of action for you to take, I would recommend that you speak to a certified financial advisor to analyse your requirements, risk profile and choice of annuity.

The right funds for a tax

unduhan-57I would like to congratulate you on your decision to use your tax-free savings account as part of your retirement planning. The biggest saving the tax fee savings account offers an individual is that you pay no capital gains tax when you withdraw money, and having a tax-free income can have a big impact in your retirement years.

The R500 000 that you are currently allowed to invest in a tax-free savings account during your lifetime is equal to investing R30 000 a year for 16 years and 8 months. The good news in your case is that if you plan to retire at age 65, your annual allowance will be invested for just more than 22 years before you start using it. That means it will be compounding during that time, and you will not have to pay any tax on the gains.

In order to maximise your return on your investment over time, however, you need a clear investment strategy to guide your decisions over time. You appear to appreciate this, as you mentioned that you do not want to make emotional decisions about your underlying investment funds.

You also realise that the investment environment has changed since last year. But if we assume that your investment period is nearly 40 years, we would expect things to change regularly over this time.

As a start, you need to write down your profit objective for your investment. You can then design an investment strategy that will give you the best chance of meeting this goal.

I cannot advise you exactly which funds to invest in, but I can give you some things to think about.

Your time horizon allows you the luxury to invest in more aggressive asset classes such as equities and listed property. Investing in these growth assets over a period of time gives you a high degree of certainty that you will beat inflation on average by 7% per annum. If you can handle volatility in the markets, then you can set that as your objective.

The next step is to design your investment strategy to be robust enough to cater for different market conditions. That means being exposed to different drivers of returns.

For example, the Divi index is essentially a value index and will perform well when that ‘style’ is being rewarded by the market. It however will also go through times when it under-performs, such as it did last year.

Similarly, there will be periods when local equity performs well, and other times when international equities deliver better returns. It is worth considering whether you should be always exposed to both, or if you can make informed decisions about when to direct your contributions to one or the other.

An important decision you need to make in this regard is whether you have sufficient knowledge of the markets to handle investments during different market cycles or whether you are prepared to pay a fee for a professional to handle your investments for you.

While crafting this investment strategy is vital, just as important is having the discipline to stick to it.  You should also have a system in place for measuring the effectiveness of your investment strategy over time.