When you and your partner retire, with a regular pay-out from one guaranteed life annuity, the income for the surviving partner is likely to reduce by up to 50%.
Niel Fourie, public policy actuary at the Actuarial Society of South Africa, said this reduction factor is a common feature of guaranteed life annuities
bought with the joint and survivorship annuity option. It is designed to pay an income until both partners in the relationship have died.
“Unfortunately not many consumers know about this reduction factor and therefore do not plan for it. While some annuities allow you to choose the reduction factor, others do not especially when the reduction factor is set by the rules of a pension fund,” said Fourie.
Fourie explained that the reduction factor is aimed to enable a couple to receive a higher monthly pension while both partners are still alive, with a reduction when one partner dies.
“The higher the reduction factor, the higher the guaranteed pension pay-out that you will receive as a couple while both of you are still alive. The lower the reduction factor, the lower the initial guaranteed pension. If you chose a reduction factor of, say, 25% when you buy the guaranteed life annuity, you and your wife will receive a lower monthly income than if you chose a reduction factor of 50%. But should you pass away your wife will receive a higher pension than if you had opted for the 50% reduction,” said Fourie.
According to Fourie, this is because a higher pension will be paid to the surviving spouse when a lower reduction factor is chosen and vice versa. The thinking is that one person has lower day-to-day expenses than two people.
What does this mean for the surviving partner?
Fourie said that if you have not planned for this sudden reduction in pension, one of you may run into financial difficulties.
“The reality is that while many expenses reduce when a spouse passes away, there are also many that stay the same or even increase. This is why it is so important for both partners to jointly select the reduction factor and understand the long-term implications of the percentage chosen. Once you have agreed to the terms and conditions of the annuity, including the reduction factor, you cannot change your mind at a later stage,” said Fourie.
Fourie said medical inflation is an example of a future expense that often foils post-retirement budgets, no matter how carefully they were drawn-up.
“Medical inflation has on average been 3% above normal inflation for the past 10 years and is usually much higher than the consumer price index (CPI). Because medical aid contributions and medical expenses usually make up a large portion of pensioners’ budgets, unplanned increases and a sudden reduction in annuity payments on the death of a spouse can cause financial hardship,” said Fourie.