First appeared in Estate Living
When reaching retirement, we’ll almost all be faced with the choice of taking either a Guaranteed Annuity (also known as a Life Annuity) or a Living Annuity.
Irrespective of other investments, if you are a member of a retirement fund * (pension, preservation or retirement annuity), you must use at least two-thirds of your fund proceeds to purchase an annuity at retirement. This annuity will provide you with a regular income (or pension) for the rest of your life. (* not applicable to a Provident or Provident Preservation fund)
It’s not an easy decision and thankfully not limited to just one or the other. You can take out both types of annuities concurrently or purchase a composite annuity (both living and guaranteed) under a single life assurance policy which is a bit of a hybrid product.
A Guaranteed Annuity / Life Annuity
The guaranteed annuity is an insurance product that you purchase from a life assurance company. The life assurer guarantees to pay you a specified monthly pension for the rest of your life which effectively insures you against the risks of living longer than expected, as well as the risk of using up your money too soon. On retirement, you would purchase the annuity by paying a lumpsum in exchange for the guaranteed monthly income (which would normally include an annual increase).
Several factors are considered when determining your monthly pension, including:
- Your age; the younger you are, the longer you are likely to live which results in a lower monthly pay-out.
- Your gender; women have a higher life expectancy than men and generally receive a lower pension.
- Interest rates; the higher the prevailing interest rates, the higher your monthly pension is likely to be.
- Your choice of annuity; depending on the exact product and benefits you opt for, the pay-out will vary. The more insurance you require, the lower your annuity will be.
You’ll receive a guaranteed monthly pension for as long as you live.
With this product your money dies with you and no money passes onto your heirs.
A Living Annuity
The living annuity is an investment product. You invest your money and can withdraw a monthly (or annual) pension that suites your needs. You do however need to work within the confines of the prevailing regulations.
One has far greater flexibility in terms of investment choices and can decide on the monthly income required. Should you have money left in the fund after your death, this will be passed on to your nominated beneficiaries. Overall you have more control of your investment.
The risk of a living annuity is that you run out of funds and are left with no pension. This could be due to poor performance in the markets, withdrawing too much for your living expenses or simply by living longer than expected.
Some points to note:
- Living annuity investors are currently not subject to Regulation 28 of the Pension Funds Act, which means that there are no prescribed investment limitations as in the case of a Retirement Annuity investment.
- You must draw a pension from your investment every year; at least 2.5% but no more than 17.5% of the annual value at the policy anniversary date. The annual withdrawal is unfortunately not an ad-hoc amount as you need to specify the draw-down rate prior to the policy anniversary date.
- You can switch product providers and are not bound to one annuity. Provided that one annuity has a minimum income of at least R150 000 per year, you can purchase up to four annuities with the proceeds of your pension fund.
- Your nominated beneficiaries inherit any remaining capital after your death and can choose to receive a lump sum, an ongoing annuity or an accelerated annuity (paying out over five years). This is not subject to Estate Duty and is taxed either per the lump sum or the individual income tax tables.
Making your decision
It’s not an easy decision to make. On one hand you have a guaranteed pension for life, but it does not transfer to your heirs. On the other hand is a more flexible investment with passes over to your beneficiaries, but you stand a risk of running out of money.
One should consider a host of factors specific to you: your health, age and life expectancy, existing investments, current income streams and the needs of your dependants. Also, where you plan to retire, how much you need and more subjectively, your investment outlook for the country.
If you plan to retire young, you should consider a low-cost living annuity as your age will be factored against you in a guaranteed annuity. If you’re older though, say in your seventies, the guaranteed annuity may be a better option as life expectancy has fallen and your monthly annuity will likely be more. You may also need your money sooner rather than later due to ill-health or other circumstances and in that case a living annuity with a flexible draw-down rate may suit you better.
There is no specific formula to apply when making this decision and it’s always best to discuss it with a trusted financial advisor. As a final though, you can switch a living annuity into a guaranteed annuity at a later stage if you change your mind; but you
cannot do the reverse.