“The best time to start thinking about your retirement is before the boss does.” (Anonymous)
If you’ve created wealth using Pension and Provident funds and/or Retirement Annuities and are nearing retirement, you’ll need to decide what you’ll do with the funds to provide you with an income in your golden years. The law stipulates that you must transfer at least two-thirds of the amount into a compulsory annuity: a Life or a Living Annuity. You can now also opt for a combo of the two.
- A Life Annuity is an insurance-based fund which provides you with a guaranteed income for the rest of your life (or, in some cases, for a specific period – read the small print carefully!). A Joint Life Annuity provides an income until both spouses pass away.
- A Living Annuity is an investment-based fund which will provide you with an income based on your selected drawdown rate (between 2.5 and 17%).
- A Life Annuity cannot be converted into a Living Annuity, but you can change a Living Annuity for a Life Annuity.
- At retirement, you can split your retirement funds between a Life and Living Annuity.
How about a combo?
You can also split the funds and purchase a hybrid annuity. This solution to retirement funds is becoming increasingly popular.
The Life section provides you with a risk-free income for life, and the Living Annuity the ability to select the underlying assets and to pass down a legacy.
Now let’s dive into the details by looking at the options from a few different investment perspectives:
- Wealth preservation
The key difference between a Living Annuity and a Life Annuity is that a Living Annuity allows you to preserve your wealth as the capital does not cease when you die. The remaining capital of a Living Annuity passes on to your nominated beneficiaries, whom you can choose freely.
Living Annuities do not form part of your deceased estate. When you pass away, the funds can be transferred directly to your beneficiaries and will not attract estate duty, thus making such products highly effective estate planning tools.
The beneficiaries of a Living Annuity have almost immediate rights to the capital value and income from the fund. They can maintain the Living Annuity in their name, withdraw all the funds to use as they see fit, or make a partial withdrawal and keep the balance as a Living Annuity.
- Level of income
If you have a Living Annuity, you can select to draw down anything from 2.5% to 17.5% of the annual value of the fund. You can change this percentage once a year on the anniversary of the inception date. You also have a choice between an annual or monthly payment. In general, if you’d like to preserve the value of your Living Annuity capital, you need to invest in funds that outstrip inflation.
If you have a Life Annuity, the income is determined by how much money you put in on Day One. You can usually select between a level or inflation-linked income. If you select a level income, it will be higher than an inflation-linked income in the initial years, after which the inflation-linked option will come into its own. Once you’ve made your selection, you cannot renegotiate it.
- Asset allocation
You can choose the underlying asset allocation within your Living Annuity. You can base the selection on your risk profile, age and drawdown amount. Some retirees who choose a Living Annuity invest a reasonably high proportion in low-risk investments and the balance in equity to ensure long-term capital growth. The funds can be rebalanced at any point.
If you have a Life Annuity, you have no say in how the life assurance company invests the funds. Because they guarantee you an income, you don’t need to get involved.
Both Life and Living Annuities are taxed as income at your marginal tax rate. Living Annuities are taxed at source (by the provider), and you can select the rate to match your marginal tax rate so that you don’t have to pay additional tax at the end of the year. When you rebalance the underlying investments in Living Annuities, Capital Gains Tax doesn’t apply.
An important aside
The Law only requires you to transfer two-thirds of the wealth from your retirement funds into an annuity. If you withdraw the remaining one-third (or part thereof), lump-sum taxes apply on amounts over R550 000. (The threshold is lower if you’ve previously withdrawn from your retirement funds.)
There are times when lump-sum withdrawals make sense. For instance, you may like to pay off the balance of your mortgage.
What’s best for you?
Living annuities give you more choice than Life Annuities, allowing you to preserve wealth. But they also carry more risk. The onus is on you and your advisor to ensure that your income lasts in retirement and that there are opportunities for growth within the fund. Living Annuities are perfect for folks who want to be actively involved and are careful about their drawdown rates.
A Life Annuity can be good if you’re not a risk taker by nature and there’s plenty of longevity in your genes. They’re also suitable for people with significant other assets to leave to their heirs.
Horses for courses
When making a life-altering decision like this, knowledge is most definitely power. Gather as much information as you can and, equally importantly, know thyself. Once you think you’ve made your mind up, schedule an appointment with your advisor to see if they agree.
Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.