Edition: September / November 2017
In-Fund Living Annuities: The Power of Scale
Just how attractive will an in-fund living annuity be for the average employee?
|Table 1: Assumptions||In-fund||Out-of-fund|
|Ongoing admin fees||R150 p.m. increasing by CPI||Nil|
|Ongoing advice fees||Nil||0.75% of assets|
|Investment management fees||1%||1.50% of assets|
|Gross investment return||CPI + 3.5%||CPI + 3.5%|
The result of the costs, annuity drawn and fund value projections are as follows after 10 and 20 years respectively:
|10 years||20 years|
|Table 2 Results||In-fund||Out-of-fund||In-fund||Out-of-fund|
|Total costs||R122 000||R248 000||R241 000||R385 000|
|Total annuity drawn||R780 000||R780 000||R1 795 000||R1 574 000|
|Fund value||R967 000||R760 000||R541 000||R269 000|
From these calculations we observe that due to higher costs, the fund value in the out-of-fund living annuity is 79% of the fund value in the in-fund annuity after 10 years. This figure drops further to 50% after 20 years.
The difference in costs also affects the income drawn from the annuity, as illustrated by the graph:
In this scenario, the initial drawdown amount in both funds increases at the same pace (50% of CPI) for the first 14 years. Subsequently, the annuity provided by the out-of-fund living annuity starts to decline as the fund value decreases to the extent that the required annual drawdown is greater than the maximum allowable 17.5% of assets.
Therefore, the member can only draw up to 17.5% of a decreasing pot each year. By comparison, the in-fund living annuity reaches the drawdown ceiling approximately five years later.
Over 20 years, the in-fund living annuity provides a greater total annuity drawdown (as shown in Table 2). Further, the drawdown provided by the out-of-fund annuity is approximately 50% of the income drawn from the in-fund annuity after 20 years.
Most employees require a certain amount in a cash lump sum when they retire, to prepare for and adjust to the next phase of their lives. But what do they do with the rest of their retirement benefit? They plan to invest it in some way to secure an income. Right?
|Mwabi. . . impact on provident funds|
Research tells us that the smart money will remain in the fund and will select the in-fund living annuity. Based on our research, a member is not likely to find a better combination of cost efficiency, flexibility and convenience in an annuity anywhere else in South Africa.
In this example, an efficiently priced in-fund annuity will offer the member 14% more in pension payouts over 20 years (R1 795 000 vs R1 574 000 in Table 2) than a typical out-of-fund alternative, leaving the member with double the assets (R541 000 vs R269 000, also in Table 2). The better option is clear.