The focus of most retirement planning is on the importance of saving for retirement. Indeed, by starting young and investing appropriately, you can have an enormous impact on the amount of money you’ll have when you retire.
Still, one of the largest and most critical challenges of retirement planning has little to do with saving: choosing the best way to access your money during retirement. As a retiree, your most important objective is to ensure you don’t outlive your assets. But how? Since fewer retired people have a defined benefit pension, the bulk of retirees rely exclusively on a combination of social security benefits and personal savings.
It certainly is possible to outlive your retirement savings. One way to minimize that risk is to take a portion of your retirement money and purchase an annuity, since a typical annuity pays you a monthly benefit for the rest of your life.
An annuity is an investment security that you pay money into, in return for which you receive regular payments for a set period of time, often times for the rest of your life. Investors, especially those who are very risk-averse, prefer annuities because they provide a steady income which is guaranteed, unlike other common investment options like stocks.
“Evaluating the endless annuity options is a tough task and has prevented many potential investors from taking a potentially important step to securing their retirement,” says Carol Kisilu, a pensions administrator at Octagon Pension Services Limited.
“On the other hand, the confusion inherent in these products has allowed less scrupulous salespeople the ability to sell a financial product (i.e., the annuity) that was completely inappropriate for the purchaser.”
Contributions to registered retirement benefits schemes are tax deductible. For example, if you earn Ksh50,000 and contribute Ksh5,000 to a registered scheme, your income tax will be calculated on Ksh45,000 and not Ksh50,000, yet your contribution of five thousand shillings still belongs to you.
Investment income earned by registered retirement benefits schemes is also tax-free. There is no withholding tax on interest or dividends and no income tax on rent of property, for instance.
The Retirement Benefits Authority says traditional systems of old-age security are breaking down, and one cannot bank on being taken care of by their children when they retire.
There are two main types of annuities: immediate annuities and deferred annuities. For immediate annuity, the investor pays in a lump sum to the issuer and promptly starts receiving payments every month. This is especially attractive for retirees who could opt to put in their lump sum retirement benefits.
In the case of deferred annuity, the investor purchases the annuity in installments over a certain time and once the fund reaches a set amount, or date, starts to receive payments. The periodic contributions that one makes here will depend largely on age at which one commences; starting earlier will mean contributing small amounts over a long period while starting late towards retirement will lead to larger amounts over a shorter period.
Age will also be one of the factors, among others like health and gender, considered by the issuer when arriving at the payouts that the investor will receive.
“These payments may have fixed or variable rates of return,” says Kisilu. If fixed, then you receive the same amount of money each month for the rest of your life. “This annuity is the best for retirees who desire a regular income and don’t want to risk losing their retirement benefits in risky investments.”
Variable annuities on the other hand have a guaranteed low rate but are tied to another security like mutual funds which could provide higher return if the market is favourable.
“The bottom line is that annuities have a guaranteed return and are one of the best vehicles for retirement investment. Rather than put lump sum retirement benefits in a new venture that may not perform as expected, and with myriad attendant risks, it would be wiser to stash part of the money in annuities where it is secure. Annuities offer consistent payouts, protection against stock market dips, and payout rates that are far higher than one could achieve with fixed income alone.”
Another advantage with annuities is that payments can be transferred to dependants. Most annuities have a guarantee period and if a retiree buys an annuity with a guarantee period of, say, 10 years, then if he dies before the 10 years are up the remainder of the annuity is paid to nominated beneficiaries.
Annuities are generally sold by insurance companies, primarily those that issue life insurance policies. Annuities are a natural extension of the life insurance business because the firm has to offer an annuity payout schedule that is based on your life expectancy. When you buy an annuity, you are presuming that you will live for a long time; whereas for a life insurance policy you insure the chance that you will not live very long.