Income Drawdown or Annuity?

Introduction
After decades of hard work, retirement is finally here, a time to enjoy your golden years. If you have been saving throughout your working life, at retirement, your accumulated retirement benefits might be one of your biggest asset. Deciding what to do with these benefits is a very crucial decision as the benefits are meant to provide for you during your sunset days. It is therefore important to choose an option that will protect your savings and afford you a sustainable income throughout your retirement years. In this note we compare the two options available to retirees, under the Retirement Benefits Guidelines, that is, either purchasing an annuity, or transferring your benefits into an Income Drawdown Fund.

Comparisons between Income Drawdown and Annuity
An Income Drawdown Fund is an investment product that allows a retiree to reinvest their accumulated retirement benefits through a fund registered by the Retirement Benefits Authority (RBA), and set up for the purpose of paying regular income to retirees. This allows a retiree to benefit from income generated from investing their lumpsum, and in turn, it translates to higher regular payouts to the member. The Retirement Benefits Regulations caps the amount that one can drawdown from the fund annually at 15% of the fund balance to ensure the funds are not exhausted during the lifetime of the member thereby providing cover from longevity risk. The drawdown frequency can either be monthly, quarterly, semi-annually or annually. The minimum drawdown period is 10 years, after which the member can opt to;

  1. Continue with the drawdown arrangement,
  2. Take up an annuity,
  3. Take the remaining fund balance as a lump sum.

An Annuity is a contract between an insurance company and an individual where in return for a lump sum of your accumulated retirement benefits, the Insurance Company will give you a periodic income monthly, quarterly, either semi-annually or annually. The type of annuity you choose and its benefits will determine the amount of income you will receive during retirement. It is therefore important to check all the options offered by various insurance companies before you buy the annuity plan that best suits your needs.

We look at the following factors as we compare income drawdown to annuities;

  1. Investment Returns – An Income Drawdown Fund allows a member to benefit from income generated from investing their lump sum. Income drawdown offers stable investment returns since the funds are invested conservatively with the aim of preserving capital, and achieving modest growth over the long-term to ensure that at the end of the drawdown period, the member has funds left in their account to continue providing for them during retirement. For annuities, the interest rate is determined at the point of purchase, usually being the prevailing interest rates and is used when determining the periodic payments and this does not change.
  2. Flexibility – Income Drawdown Funds are considered more flexible than annuities as the member choose how much they wish to withdraw and the frequency, monthly, quarterly, semi-annually or annually. A member can also change the amount of drawdown at a frequency that will be agreed on with the income drawdown provider. Annuities on the other hand lack the flexibility offered by income drawdown, once you purchase an annuity, you cannot change it.
  3. Transparency There is transparency in the management of Income Drawdown Funds with members having the opportunity to interrogate the audited financial statements, attend annual general meetings, and receive their individual balance statements on a regular basis, an option that is not there with annuities
  4. Income Guarantee – Annuities can be used to guarantee an income for a given time period. A lifetime annuity is used to provide a regular income for life, and will continue paying out no matter how long you live. With an Income Drawdown Fund, there are no guarantees the income you draw will last for life, as when you reinvest your retirement benefits they become vulnerable to market performance.
  5. Inheritance – Income Drawdown Funds give the member the opportunity to leave an inheritance for their beneficiaries in the event of demise as they get the remaining fund balance. On the other hand, the type of annuity you purchase will determine whether it continues to pay out after you die. If you purchase a single-life annuity, it will only pay an income to you, and after you die all remaining funds will be kept by the insurer.

Factors to consider when choosing between Income Drawdown and Annuity

Some of the factors that one should consider when choosing between annuities or income drawdown include;

  1. Diverse Income Sources – Retirees with other income sources other than their retirement benefits are able to take up more risks than retirees who only depend on their retirement benefits,
  2. Age – Retirees have varying risk appetite mostly dependent on their age. With the normal retirement age in Kenya being between 50 years and 75 years, people who retire at 50 are able to take up more risk while those who retire later than 70 years are not able to take up much risk,
  3. Dependents – Income drawdown is more suitable for members who have dependents as it allows for inheritance. In case of death, a member may leave their funds to their beneficiaries,
  4. Health – The status of your health will most likely determine how long you will live post retirement, good health will mean that you are likely to live long after retirement. You do not want a scenario where you outlive your retirement savings. One might therefore consider a combination of annuity and income drawdown, the annuity would ensure certainty that you have income no matter how long you live, income drawdown will give you better payout translating to improved life at retirement.

Conclusion
It would be fallacious to generally conclude that one option is suitable for all members. We would recommend that one seek professional advice when making this important decision as people have different needs at retirement and should make decisions that suit their needs. The features of the two options covered above are to guide you and enable you to formulate a retirement plan that will enable you to enjoy a sustainable lifestyle in retirement.

For such advice, please contact Genghis Capital Ltd on 0709 185 000, or send an email to info@genghis-capital.com

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