Retirement marks the start of a significant life transition. On the financial front, the biggest adjustment is moving from working for and earning a monthly income to relying on alternative income streams and accumulated savings. This shift can be challenging for many individuals. Around the world, retirees face the critical decision of converting their retirement savings into a steady income stream. While financial consequences are well documented, the effects of these choices on mental health are less frequently explored.

Research highlights that financial security is closely tied to mental well-being in retirement. Retirees with stable incomes often report better mental health outcomes and increased life satisfaction. Financial uncertainty can have a substantial effect on mental health. Our finances significantly impact our emotional health because money influences various aspects of our lives, from basic needs like housing and food to long-term goals like retirement.

This Hot Topic examines how retirement income choices, particularly living and life annuities, impact financial well-being and mental health.

Quick recap: Life versus living annuities

While saving for retirement might feel like a new concept, it dates back to the Roman Empire. Formerly known as a “perpetual annuity”, citizens could receive a lifetime stipend in exchange for a one-time payment.

In modern-day South Africa, retirees are generally presented with two primary annuity options: a living annuity and/or a life annuity.

• Living annuities allow flexibility, enabling retirees to withdraw between 2.5% and 17.5% of their investment value annually. This option allows for greater control over investments and offers the potential for higher returns, but it also carries investment and longevity risks.
• Life annuities provide a guaranteed monthly income for life, transferring the investment risk to an insurer. While this option provides financial certainty, it lacks flexibility and potential for capital growth.

It’s important to note that Life annuities offer security (via a guaranteed income) while living annuities provide flexibility (via investment choice and income levels). With life annuities, the insurer bears the risk. In contrast, with living annuities, the retiree manages the risk.

Choosing between these options depends on an investor’s personal risk tolerance, investment knowledge, and need for income security or flexibility – to name but a few. It is recommended that investors consult a financial adviser to unpack each product to see which structure is best suited to their investment needs.

According to the Association for Savings and Investment South Africa (ASISA), living annuities account for 90% of new annuity policies issued at retirement. It would appear that South Africans have a clear preference for living annuities.

Financial and mental health trade-offs: Studies indicate a preference tilt to living annuities for retirees. We unpack why:

Retirees want to retain autonomy over their finances

• While market volatility, income sustainability, and the overall performance of living annuities can negatively affect some retirees, studies show that individuals with living annuities often report higher satisfaction levels due to the autonomy they retain over their financial affairs.

Retirees prefer to have choices and be agile in their investment approach

• The above trend is echoed globally, particularly in the United States, where retirees who manage their investments report better psychological well-being, linked to the control they have over their financial choices.
• Retirees with flexible income products (such as living annuities) tend to experience better financial outcomes because they can adapt to changing circumstances. The ability to adjust one’s financial strategy in retirement can lead to increased satisfaction and a stronger sense of control over one’s future.

Retirees are willing to take on a bit more risk, in return for flexibility

• While retirees recognise longevity risk, they also recognise that living annuities offer investors the opportunity of continued growth of the capital amount invested (through investment growth) while still drawing an income.
• Efficient investment management combined with the correct drawdown rate is an important consideration, especially if an investor wants to preserve and grow their capital amount. To manage these risks, retirees often need to work closely with asset managers and financial advisors, ensuring they employ effective investment strategies that maximise returns and reduce stress related to market volatility.

Retirees want to preserve (and grow) their capital amount

• If invested correctly, a retiree’s investment could achieve annual returns that exceed inflation. This growth can extend the longevity of retirement funds, improving both financial security and mental well-being.
• Retirees can adjust withdrawal rates in response to market conditions, preserving capital during downturns and benefiting from growth during upswings. This flexibility provides an additional layer of protection against financial uncertainty.

Life annuities offer a different peace of mind – not outliving one’s savings

Life annuities provide a different peace of mind by providing a predictable, guaranteed income – alleviating anxiety about outliving one’s savings. This reduced financial stress leads to better mental health outcomes for retirees. The trade-off, however, is the lack of control over investment decisions, which some retirees find limiting.

Whether an investor decides to invest in a living annuity or a life annuity, both options provide an income at retirement, contributing to better financial security and the retiree’s mental well-being. Ultimately, both approaches have trade-offs, and careful management or guidance from financial advisors is essential for balancing long-term financial security with mental wellness.

Why our finances and emotional well-being are so closely connected

• Financial stability provides a sense of security. When individuals have stable incomes and savings, they feel more in control and less anxious about the future.
• Our financial affairs impact our self-esteem and self-worth. Financial achievements can foster a sense of accomplishment and personal pride. Achieving financial goals we set for ourselves can be empowering, adding to our self-esteem.
• Finances impact the wellness of relationships. Effectively communicating about money matters and having a healthy relationship with our money, can benefit relationships by removing unnecessary tensions. Disagreements about spending, saving, and financial goals can strain relationships, leading to emotional distress.
• Research has shown a strong link between financial problems and mental health issues. Financial stress can impact our mental health in various ways, such as added anxiety and sleepless nights. A lack of financial resources can also limit access to mental health care.
• Financial independence gives people a sense of control over their lives, allowing them to make choices that align with their goals and values.

In conclusion

By setting clear financial goals, you ensure that your retirement years are more predictable and secure. With adequate financial planning, retirees can design the lifestyle they want, whether it includes travelling, hobbies, or leaving a legacy to children and grandchildren. It ensures your savings will align with your retirement aspirations.

The choice between living and life annuities is a personal one, with each offering different benefits and risks. Balancing these options requires professional advice, careful planning, and regular reviews to ensure financial stability and mental well-being throughout retirement.

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