A significant part of a financial planner's role is to provide clients with peace of mind regarding their investment portfolios. We have various tools at our disposal, including diversification across asset classes, the purchase of guarantees, and an understanding of cash flow requirements.

These tools are often linked to market performance and come at a cost. Another valuable tool is the use of life annuity rates, particularly in the annuity space. For clarity, the difference between a life annuity and a living annuity is significant.

A living annuity invests in chosen funds, with the investor selecting an annual income percentage between 2.5% and 17.5% per annum. The longevity of the capital and income depends on market performance and the chosen income level. If funds remain upon the death of the annuitant, these funds are paid to beneficiaries either as income or capital, with varying tax consequences not covered here.

"A life annuity guarantees a fixed income for the investor's lifetime, regardless of market performance, with no changes allowed after inception.”

No alterations can be made once established. For example, you can choose for the income to increase annually and set the number of years the income is guaranteed. This is crucial, as there is no investment value on death if the annuitant passes away early.

Life annuities have fallen out of favor over the past 20+ years due to lower income rates, lack of flexibility, and the absence of a capital payout at the end of the period, usually at the death of the annuitant or the end of the guaranteed period, whichever occurs last.

However, there are times when the rates on insurance-linked products are so attractive that they potentially override traditional objections to using these products.

Currently, the rates on life annuity products are at highs not seen in over two decades.

This may allow certain investors to lock in guaranteed returns that are not linked to the performance of listed markets such as equities and bonds.

For high-net-worth clients who wish to diversify a portion of their portfolio away from market risk, they can place a portion into a life annuity, thus taking on longevity risk. Where these funds are no longer impacted by the markets, the risk is that they die before achieving return parity.

To illustrate, let’s consider an example. A client aged 75 wants to protect 10% of their portfolio against market risk and agrees to place R1,000,000 into a life annuity. At current rates with a well-known insurer, the income they will receive is R99,443 per annum, increasing by 6% per annum, with a 10-year guarantee term. Comparing this to investing R1,000,000 into a living annuity, assuming a 10% per annum return after fees, the capital in the living annuity will be depleted in year 15, and the total income received over this period would be R2,222,267.

However, the life annuity would pay an income of R224,831 in year 15, with a total received of R2,314,632, and the income will continue for the investor's lifetime. If the investor lives another 5 years to age 95, the total income received would be R3,976,996. The client should consider two risks: if inflation spikes beyond the 6% income growth rate and if they die before reaching parity. The latter is partially mitigated by incorporating the 10-year guaranteed term, ensuring beneficiaries receive income up to year 10.

With careful planning and as part of a risk mitigation strategy, this trade-off can be worthwhile. Should the investment return reduce to 8% per annum over the period, the difference is R459,000, and if the return is 5% per annum, the difference would be R177,000.

As the great Thomas Sowell said, “there are no solutions, only trade-offs.” This applies to investments as well.