Retirement is a significant milestone in one’s life, a time when the financial resources accumulated over years of hard work should provide peace and security for the golden years ahead. However, a report from Genesis Analytics in partnership with the Financial Sector Conduct Authority (FSCA) showed that 90% of South African retirees cannot maintain the same standard of living prior to retirement. This is a frightening statistic, which can be exacerbated during the financial planning process through the provision of substandard advice and poor recommendations. It is therefore vital, as will be set out below, for both parties, the financial services provider and the clients to ensure that they are committed to ensuring the financial planning service results in outcomes that benefit the client and make the most of whatever retirement provision may have been made.
Whilst we shall be focusing on retirement planning at retirement, in other words, the options available in respect of the annuities available at retirement, it must be appreciated that a significant aspect that affects the financial planning conducted at retirement is due to the client not having made sufficient provision for retirement. This can then be exacerbated by the client’s desire to maintain his/her standard of living and the need to draw a specific level of income that simply cannot be supported by the retirement savings accumulated. Therefore, Financial Services Providers (‘FSP’), such as financial planners, brokers, and intermediaries, need to have honest and frank discussions with their clients to manage expectations. Equally it requires that clients appreciate that they may not have made sufficient provision for retirement and that they consider the recommendations made and look to make whatever changes they can to their budgets to cater for the annuity income that can be provided by the capital invested.
One of the key decisions at retirement involves choosing between either a Living Annuity or a Life Annuity. If one has saved for retirement utilising a pension fund, provident fund, or retirement annuity, these are the only two choices available to you, although recently we have seen the introduction of hybrid products that incorporate elements of both types of annuities. In addition, the decision you make, especially in respect of a life annuity cannot be undone, due to legislation currently in place. The restrictions in accessing the funds within these two annuities, make this an important decision, that require that the client be placed in a position to make an informed decision.
A living annuity allows one to choose the level of income from between 2.5% and 17.5%. It also allows you to select the portfolio’s invested in so that it can better align with your risk tolerance as well as established needs. However, the most appealing aspect of a living annuity would appear to be that the funds will be available for any dependants upon the passing of the life assured. Conversely, the risks involved in this annuity are significant, as any annuity income drawn more than 4/5% will eventually lead to the erosion of capital, and so one is entirely dependent on the performance of the underlying portfolios. There is a real risk that one can outlive the original capital invested. Therefore, whilst leaving a legacy to one’s dependants etc. may be a noble endeavour, the objective of an annuity is to provide an income for life, and so a living annuity may not be the most appropriate option for a prospective client, especially in respect of small investment amounts that may require a larger income drawdown offers retirees flexibility in managing their retirement savings.
The other option involves what is commonly referred to as a life annuity, in which in return for a lumpsum investment one receives an annuity income that is guaranteed for the life of the life assured. It must be appreciated that no changes can be made to the income frequency or level of income after the annuity is put in place, so one must make sure that factors such as inflation are taken into account to determine the frequency of the income payable together with whether the income will increase at CPI, whether the annuity will be a joint or single annuity and whether there will be a guaranteed income term, usually between five to ten years. All these considerations will impact the final annuity income payable. Therefore, careful focus is required, as the final decision cannot be amended. Whilst this annuity does not provide any capital to dependants after death of the life assured, one can opt for a life cover option that can cover any specific percentage of the invested capital. This life cover will be separate from the annuity, and the premium will be deducted from the income before it is paid to you. It’s important to note that the life cover will significantly affect your income, provided you qualify for coverage based on your medical health and history.
The Office of the FAIS Ombud has observed several complaints stemming from the financial service rendered at retirement, and it is important to note that in the case of a living annuity, the focus needs to be on preserving the capital, not only for beneficiaries, but to ensu re that the annuitant can continue to benefit from the annuity income for his/her entire life.
The importance of selecting an optimal level of income that can be supported by the selected portfolios cannot be emphasised enough. It necessitates close cooperation between both the client and financial intermediary. In turn, this requires the financial services provider to manage the client’s expectations and ensure the client is placed in a position to make an informed decision.
In respect of life annuities, where the income is guaranteed for life, considerations must be had in respect of whether the income will remain constant or increase annually to provide for the effects of inflation, and if there is a need for a joint life annuity or whether you require a guaranteed term. All these options will affect the ultimate annuity payable, and so careful considerations must be made in this regard as well as whether to provide for dependants by way of a life cover policy. Again, this requires that the financial services provider manage the client’s expectations and that the client is placed in a position to make an informed decision.
Case 1:
The complainant, now 63 years old, conveyed that on 22 February 2017, he acquired a Single Life annuity. Subsequently, on 2 August 2021, he transitioned fund managers. Stating his case, the complainant mentioned that the annuity policy currently stands at a value of R1,400,000. Due to unforeseen circumstances, he found it necessary to claim some funds from his plan to prevent losing his home due to an outstanding amount of R150 000. Following advice from an independent financial advisor, he sought to change the payment frequency from monthly to annually. This adjustment would facilitate releasing the funds essential for settling the outstanding home balance. Promptly, he requested his financial advisor to effect this change to his lifetime policy plan.
Expressing discontent, the complainant highlighted the denial to change the payment frequency. He argued that the financial advisor overseeing the policy transfer had neglected to thoroughly explain all available options, failing to recommend alternatives that aligned better with his financial needs. Despite the complaint and the relief sought, the FAIS Ombud clarified the constraint: the payment frequency of a life annuity cannot be changed.
Case 2:
The complainant, a professional nurse, faced a critical financial decision when her employer altered the pension fund administrator, granting her access to retirement benefits at 55. With pension benefits valued at approximately R300,000, she chose to receive a one-third lump sum and invested the remaining two-thirds, R207,174.57, in a compulsory annuity, ensuring a monthly income for life. Post-resignation, she engaged in contractual work with NGOs, finding her monthly income insufficient to cover living expenses. Attempts to enhance this income proved futile.
Reviewing her financial situation, she discovered the possibility of alterations to her i nitial plan. Seeking financial relief, she wished to access the capital used for the compulsory life annuity, hoping to regain her investment and improve her financial situation. However, legislative restrictions, as outlined in the Income Tax Act, prevented the requested access to the funds utilized for the life annuity purchase.
In both cases, our office couldn’t aid the complainants, as they were already informed about their annuity options and how they function. A common issue in these cases is a misu nderstanding of the flexibility and limitations of their chosen annuity plans. Lack of comprehension regarding the flexibility of annuity plans can lead to financial strain, missed opportunities for adjustments, and potentially inadequate funds to sustain a comfortable retirement.
- When purchasing annuities, consumers should consider the following:
Conduct your own research: Understand all available options and implications before committing to an annuity. This will allow you to ask questions of your financial services provider regarding any recommendations being made, putting you in a position to make an informed decision.- Ask questions: As mentioned above, your financial services provider must provide youwith the information you require regarding the implications and consequences of the options available to you, to ensure that you can make an informed decision as to what is in your best interests. Being informed and asking questions to gain further understanding will only benefit this process.
- Review Options Periodically: Regularly assess the adequacy of the chosen plan and explore possible adjustments. This is especially true in respect of a living annuity which requires constant monitoring and evaluation to ensure that the growth of the portfolio is providing for the income drawdown selected.
- Consult Independent Financial Advisors: Seek advice from qualified professionals who can provide unbiased guidance on the most suitable options.In closing, it is not the responsibility of the financial services provider to make up for the lack of one’s retirement provision by simply looking to maximize income at all costs. However, the financial services provider does have a duty to ensure that whatever your retirement savings may be, you are provided with a recommendation that is appropriate to your needs and circumstances and that will provide one an annuity income for life based on the level of sa vings at retirement. It is therefore vital that financial services providers manage expectations to ensure that the client is placed in a position to make an informed decision in respect of what is a very important and binding decision.For more information and assistance, please visit the FAIS Ombud website at www.faisombud.co.za or contact us directly at info@faisombud.co.za.
