Choose a guaranteed income in retirement

In recent years there has been a growing focus on investing for an income in retirement as opposed to just targeting the best possible investment return.

Investors know what their salaries are today and want to replace it (or a portion of it) in retirement, but often only really find out what income they would be able to purchase on the day of retirement.

It is this gap that Liberty Investments hopes to fill with its Agile Retirement Range.

What it is

The Agile Retirement Range includes a retirement annuity and preservation fund products and aims to find a balance between investment returns and income certainty. Investors can choose from a range of roughly 100 underlying investment portfolios from 15 asset managers, including a variety of low cost index-trackers and can spread their contributions across these funds. Minimum investments are R1 000 monthly or a R15 000 lump sum.

One of the underlying portfolios is the Exact Income Fund, which Liberty manages internally. It is this fund that provides income certainty.

Investors who want a higher level of income certainty in retirement could allocate a higher proportion of their monthly contributions to this fund, while investors who want to invest for growth may want a lower (or no) allocation to this portfolio. The assets invested in the Exact Income Fund will be converted to a Liberty life annuity in retirement. The assets invested in other funds can be used to buy a life annuity or a living annuity from anybody in the market at retirement.

Since the Exact Income Fund is considered a low risk portfolio, investors with more than 20 years to retirement won’t be able to invest in this portfolio.

Mark Lapedus, head of product development at Liberty Investments, says it will guarantee an income in retirement each time a contribution is made into the Exact Income Fund. The income is guaranteed no matter what happens to markets, interest rates or currencies between now and the time of retirement.

The level at which income is guaranteed

Lapedus says the age and gender of the investor and the time left to retirement will determine how much an amount invested today will guarantee in retirement income. A 40-year old female and a 60-year old female who will both be retiring at 65 will buy a different level of guaranteed income.

But how would an investor know if this is good value for money?

One possibility is to compare the level of guaranteed income and the investment returns in the scenario with the returns the investor would reasonably expect from a typical Balanced Fund over the same period, Lapedus argues.

A 40-year old male who invested a R100 000 lump sum in the Exact Income Fund can expect a guaranteed income of R3 240 in retirement at age 60 (in today’s money). If an investor retired at age 60 today and wanted R3 240 a month as income, he would need R380 000, Lapedus says.

“So effectively what we are saying is your R100 000 is going to grow to R380 000 after all costs in 20 years’ time and that annuity rates of today will still be applicable in 20 years’ time,” he says.

For R100 000 to grow to R380 000 in 20 years after costs would translate to a 6.9{3f122c2f069eda3d0860a1f81bf979c88e8fd4d59794181835181851b7558327} per annum return. In a typical Balanced Fund the overall costs would be roughly 2{3f122c2f069eda3d0860a1f81bf979c88e8fd4d59794181835181851b7558327} per annum and to target a 6.9{3f122c2f069eda3d0860a1f81bf979c88e8fd4d59794181835181851b7558327} return after costs, the return have to be around 8.9{3f122c2f069eda3d0860a1f81bf979c88e8fd4d59794181835181851b7558327} per annum before costs.

“So if I were to earn an 8.9{3f122c2f069eda3d0860a1f81bf979c88e8fd4d59794181835181851b7558327} return on my portfolio over the next 20 years and there is absolutely no change in the annuity rates between today and 20 years’ time, I actually wouldn’t care whether I went into the Exact Income Fund or the XYZ Balanced Fund that gave me an 8.9{3f122c2f069eda3d0860a1f81bf979c88e8fd4d59794181835181851b7558327} return over the period,” Lapedus says.

But if there were a fairly high degree of certainty that the XYZ Balanced Fund would deliver a return much higher than 8.9{3f122c2f069eda3d0860a1f81bf979c88e8fd4d59794181835181851b7558327} per annum, the conclusion would be that the Exact Income Fund is poor value.

While Balanced Funds in general over the last ten years provided investors with a return of roughly 13{3f122c2f069eda3d0860a1f81bf979c88e8fd4d59794181835181851b7558327} after costs, fund managers are cautioning that returns are likely to be lower in the coming years, but with a lot of risk, he says.