Living Annuities Explained: How A Living Annuity Works in South Africa

• A living annuity gives retirees flexibility over their income drawdown rate and underlying fund selection, but it needs to be managed carefully to support long-term sustainability.  

• Drawdown rate, fees, inflation, investment returns and fund selection all play a major role in how long your annuity capital may last.  

• Investors should review their annuity each year, including income needs, fees, fund selection, tax, investment performance and beneficiary nominations.  

 A living annuity is a post-retirement investment product that allows you, as a retiree, to draw an income from your annuity while the remaining capital is invested in the market. This type of annuity offers you flexibility and control, but with this comes responsibility and the need for careful planning.   There are a number of factors that may play a role in the potential growth as well as the sustainability of your annuity over time. These factors include fees, asset allocation, fund selection, drawdown rate, and investment returns. In this article, we will take a deeper look at how living annuities work and the factors that you need to keep in mind as an investor. 

What is a living annuity? 

A living annuity is a flexible investment product which has been funded with your retirement savings from your retirement annuity, preservation fund or similar source, upon retirement. The current retirement age in South Africa is from age 55. As an investor, you will have two major decisions to make. You will need to decide on your annual drawdown rate, which is the income which you withdraw, as well as how your capital is invested.  You are able to select a drawdown rate of between 2.5% and 17.5%. This may be amended each year at your policy anniversary date. The policy anniversary date is the key date at which you started your annuity. The frequency that you receive your income payments can also be set according to your preferences. You are able to select from annually, bi-annually, quarterly or monthly, depending on how you like to receive your income.   

Living annuity flexibility  

A key benefit of living annuities is their flexibility. You can adjust your drawdown rate annually and switch your underlying funds to suit your needs. They also give you options for how the remaining capital can be handled when you pass away.  Any residual capital may be paid directly to nominated beneficiaries outside of the estate upon your death. This means less tax exposure, as it allows you to remove assets from your estate. It is important that you carefully manage your annuity, as the decisions you make may affect its long-term sustainability.  

This kind of flexibility can be useful because your retirement needs may change over time. Each decision, however, needs to be carefully managed, as you bear the investment risk and responsibility for ensuring your capital lasts as long as you need it.  

Drawdown rates: Why they matter 

The drawdown rate that you select may have an impact on the sustainability of your annuity capital. Your annuity will need to provide you with an income for the duration of your retirement, so it needs to be carefully managed. A drawdown rate of 4% is generally considered sustainable by financial experts, as research by William Bengen shows.   

Of course, this is not a guarantee. A drawdown rate that is too high may mean that less of your capital remains invested to potentially grow, whereas a lower drawdown rate may mean there is more capital available to potentially compound and grow over time. Your drawdown rate should therefore be reviewed alongside your investment returns, fees, inflation and income needs. If your expenses increase or markets perform poorly, the rate that once seemed appropriate may need to be reconsidered. Reviewing your drawdown rate each year can help you assess whether your annuity is still aligned with your retirement income needs and long-term financial plan.  

The golden equation  

One useful planning tool to consider is the golden equation. It is as follows:   

Drawdown rate + fees + inflation ≤ investment returns

In other words, you would ideally want investment returns to cover your drawdown rate, fees and inflation. If drawdown rate, fees and inflation are more than your investment returns, you may see your annuity reduce in value over time. The golden equation can be a useful guideline when it comes to managing and planning your annuity, but once again, there are no guarantees. 

Living annuity fees and why they matter 

Fees are an incredibly important consideration, as they may play a role in the sustainability of your annuity over time. While fees are often overlooked by investors, they can have a significant impact on retirement outcomes. High fees may reduce the returns that you have available to reinvest, whereas lower fees may mean more available returns to reinvest to potentially grow and compound over time.   Let’s have a look at some of the common fees you may come across:  

• Administration fees: There will be administration fees for any admin-related tasks like tax and reporting. 
• Management fees: The fees charged for the management of the fund.  
• Advisor fees: If you are making use of an advisor, you will likely be charged an initial and an ongoing fee for the advice that is provided. 

Some important terms that you may see on your investment statement are the following:  

• TER (Total Expense Ratio): This is a way to compare operating costs of funds that are similar. It is the ongoing expenses within an investment fund. 

• TIC (Total Investment Charge): This can be a way to compare the full cost of the investment portfolio. This charge combines the TER with transaction costs within the fund.  

• EAC (Effective Annual Cost): An annualised estimate of the impact of product, investment management advice, administration fees, and all other applicable charges.  

The Effective Annual Cost (EAC) gives investors a standardised way to understand the full cost of holding an investment over time. Introduced by ASISA, the EAC combines various charges linked to an investment into a single annual percentage. Depending on the product, this may include investment management fees, administration costs, advice fees, penalties, guarantees and the effect of loyalty bonuses. As such, investors can more easily compare the cost structures of different products and providers on a more consistent basis.   

Assuming all other factors are equal, a lower EAC generally means that a larger portion of your money remains invested and available to potentially earn returns. A higher EAC may place greater pressure on net returns as fees accumulate over time. Costs should not be considered in isolation, as factors like investment strategy, risk, service and product features also matter.   We will now have a look at an example showing the effects of fees. Let’s assume the following information in our example:   

• Starting capital: R10 million  
• Investment period: 25 years 
• Annual inflation: 5% 
• Gross annual return: 10% 
• Annual drawdown rate: 4% of the opening value each year 

Scenario 1 - 0.86% Fees: After 25 years, the annuity would have an estimated inflation-adjusted value of around R10.6 million.   

Scenario 2 - 3% Fees: After 25 years, the annuity would have an estimated inflation-adjusted value of around R6.3 million.    

We can see how small differences in fees can add up over time, leading to major differences in retirement outcomes. This example is for illustrative purposes only and real results may vary. If you would like to find out more about the effect of fees, this article may be of interest. 

The 10X fees are kept low, transparent and simple to understand. Please explore our products if you would like to find out more about the applicable fees.  

Understanding funds for living annuities  

As an investor, you are able to select your underlying funds. Asset allocation is the mix of the asset classes that your capital is invested in. This will usually be a mix of equities, real estate, bonds and cash. Your selected mix will depend on factors like your risk profile, investment timelines and your long-term financial goals and plan. 

At 10X, you do not need to choose individual assets to invest in, but instead, you may select from a range of diversified 10X investment funds. Asset allocation can be important when it comes to the potential growth of your capital over time, as this research from Brinson, Singer and Beebower highlights. 

Equities can be included in a portfolio with the aim of providing long-term capital growth and potentially inflation-beating returns. Equities may come with market declines, but they will also provide exposure to a wider range of companies and economic growth. There may be value fluctuations over the short term, so they may be more suited to you if you have a longer investment horizon and if you are more comfortable with a degree of risk. 

Real estate will give you some exposure to real assets and economic activity, while also bringing in income through rentals and distributions. You may also see long-term portfolio growth. Listed property may also be volatile, as it can be affected by interest rates, economic conditions, occupancy levels, and numerous other unpredictable factors. Real estate could also be a good hedge against inflation. 

Bonds can provide income, diversification, and a measure of stability within a portfolio. They may be less volatile than equities, but they do still come with some risk. They may be affected by factors like changes in interest rates, the ability of the issuer to repay its debt and more. Bonds are generally seen as more conservative, but they still have the potential to outperform expectations.  

Cash is usually the most liquid and stable of the asset classes. It is generally more stable than equities or real estate. Cash returns may not be able to keep up with inflation, which may affect purchasing power.  

Living annuities are not subject to Regulation 28 of the Pension Funds Act. This means that you are not restricted when it comes to how much exposure to equities and offshore that you include in your portfolio. 

Our funds at 10X are well-diversified - allowing you to choose a fund that aligns well with your investor profile and long-term financial goals. If you would like to find out more about our fund selection options, please visit our funds page.  

Living annuities and tax 

The income that you draw from your annuity is taxed. The amount of tax that you pay will be determined by which tax bracket you fall into. Lower income may mean you pay less tax, and perhaps even move into a lower marginal tax bracket. The tax that you pay will be pay-as-you-earn (PAYE) tax. Your tax rate is determined according to the total income that you earn and not just your annuity income. This will include income that you may receive from other sources, so it is important that this is also factored into your sums and planning.  

This is particularly important if your income changes from year to year. For example, you may start consulting, receive rental income, earn interest from savings or draw income from another investment. These changes could affect your taxable income and the amount of PAYE deducted from your annuity payments. Reviewing your tax position each year can help you make a more informed decision about your drawdown rate and avoid being caught off guard by your overall tax liability.  

What happens to a living annuity when you die? 

It’s important to ensure that your beneficiary nominations are up to date and accurately reflect your wishes. These nominated beneficiaries will receive the money left in your annuity when you pass away. In addition, a nominated beneficiary can pass on any residual value remaining in the living annuity to their nominated beneficiaries.  

If you haven’t nominated any beneficiaries, then the remaining capital may go to your deceased estate and will be paid out according to your testamentary wishes. This may be a long and expensive process. By nominating beneficiaries, you may be able to ensure that your annuity will not be subject to estate duty. Without a nominated beneficiary, the remainder of your annuity may form a part of your estate and be taxed accordingly. Estate duty is 20% for estates valued up to R30 million and 25% for estates valued at R30 million or more.  

Beneficiaries may have different options available to them, depending on the product rules and tax treatment at the time. They may be able to take the remaining value as a lump sum, continue to receive an income through an annuity, or choose a combination of both. This is why it is important to keep your beneficiary nominations up to date and ensure they still reflect your wishes.  

How often should you review an annuity? 

You would ideally look to review your annuity annually, prior to the policy anniversary date. There are a few important factors to consider when you are reviewing your annuity. Generally, you should review fees, fund selection, your income requirements, drawdown rate, tax, investment returns and nominated beneficiaries. All responsibility lies with you, so it’s important to manage these factors carefully to help sustain your annuity over time and align with your long-term financial goals. 

This review should focus on both the year ahead and whether your annuity is still suitable for your broader retirement plan. Your health, expenses, tax position, market conditions and beneficiary wishes can all change over time, so an annual review can help you make more informed decisions and avoid letting your annuity drift away from your long-term goals 

Final thoughts on living annuities in South Africa 

A living annuity is a flexible retirement product that gives you control over your income drawdown rate and how your retirement savings are invested in the market. As an investor, you’ll have to carefully manage your annuity to ensure that it remains sustainable throughout your retirement years. This means conducting an annual review on your policy anniversary, focusing on your income requirements, drawdown rate, fees, fund selection, asset allocation, tax, and beneficiary nominations.  

The 10X Living Annuity offers low, transparent fees and access to a range of well-diversified funds, including 100% offshore exposure. Get in touch with 10X Investments to learn more.