The Living Annuity for self-employed retirees

• A living annuity offers self-employed retirees flexibility over their retirement income and investments.  
• Drawdown rates, fees, tax and fund selection affect long-term retirement sustainability.  
• Direct investing, annual reviews and 10X’s online tools can help retirees manage their living annuity.  

A living annuity is worth serious consideration for self-employed retirees. Your path to retirement may differ from that of someone who has spent their career in formal employment, but a living annuity remains an appealing option for anyone preparing for retirement.   

When formally employed, you may have had a pension or provident fund through your employer. As a self-employed worker, your retirement savings may instead have been spread across different products, such as a retirement annuity and preservation fund. This kind of annuity is a great way to convert savings into income for your retirement years. In this article, we take a more in-depth look at how you could use a living annuity as a self-employed retiree and the factors you need to consider when managing your living annuity. 

What is a living annuity and how can it support self-employed retirees 

A living annuity is a flexible post-retirement product where your savings are invested in the market while you draw an income from the capital. It is funded by savings transferred from retirement savings products, such as retirement annuities or preservation funds, upon retirement. It may be useful if you are an investor who prioritises flexibility, as it offers you control over both the income you draw and the funds your capital is invested in. Your drawdown rate is the income that you draw from your annuity each year. This may be a rate of between 2.5% and 17.5%. This can be amended annually at the policy anniversary date.  

You can also select the frequency at which you receive your payments. Additionally, you can choose from annual, biannual, quarterly, or monthly options depending on your preferences. With this flexibility comes responsibility, so it is important that you carefully manage your annuity to help ensure your capital lasts through your retirement years. 

Drawdown rates: Choosing your income 

As previously mentioned, you can select a drawdown rate between 2.5% and 17.5% per annum. It is important, however, to keep in mind the sustainability of your annuity capital. Ideally, the capital should be able to provide for you for the duration of your retirement years. This means you would aim to select a sustainable drawdown rate. This allows for more of your savings to remain invested and available to potentially grow over time. A drawdown rate of 4% is considered sustainable by industry experts, as research from William Bengen indicated, but this isn’t guaranteed, and circumstances will differ from person to person.  

 You may also like to consider the golden equation. This equation is stated as:

Drawdown rate + fees + inflation ≤ investment returns.

This useful planning tool can help when it comes to determining the drawdown rate. Ideally, your investment returns should exceed the sum of your drawdown rate, inflation rate and fees. If not, you may see your capital decline in value.  

Tax considerations for self-employed retirees 

When it comes to tax on your living annuity, tax is paid on the income that you draw from your living annuity. Drawing less income from your annuity may mean that you pay less tax overall, depending on which tax bracket you are currently in. The tax paid is pay-as-you-earn (PAYE) tax. As a self-employed retiree, you may have income from a variety of different sources, so it’s important to remember that your tax rate is determined according to the total income that you earn - it is not based on your living annuity income alone. Any additional income that you receive may then place you in a higher tax bracket, so it’s important to consider all income streams when budgeting. 

The importance of fees 

High fees may have the effect of reducing the returns that you have available to reinvest in your living annuity. On the other hand, lower fees may mean that there are more returns available to reinvest in your annuity to potentially grow over time. Fees should be carefully managed when it comes to living annuities, as you are also drawing an income from your annuity capital.  Let’s look at an example which can help to show the effect of fees on a living annuity. We will assume the following information for this example:   

• Starting capital: R6 million  
• Investment period: 25 years 
• Gross annual return: 10% 
• Annual inflation: 5% 
• Annual drawdown rate: 4% of the opening value each year  

 Scenario 1 - 0.86% Fees: After 25 years, the annuity would have an inflation-adjusted value of approximately R6.4 million.   

Scenario 2 - 3% Fees: After 25 years, the annuity would have an inflation-adjusted value of approximately R3.7 million.  

A small difference in fees has a potentially huge impact on retirement outcomes. This example is for illustrative purposes only and real results may vary. You can learn more about fees here.  Here are some of the usual fees you may find charged:  

• Management fees: These are the fees which may be charged for the running and management of the fund. 
• Advisor fees: If you have an advisor, you may find you are charged fees for the advice provided and any other additional services that may be offered. 
• Administration fees: There will be a fee charged for administration. This will be for tasks like tax, compliance and reporting.  

 You should also understand the following terms you may come across when reviewing costs:  

• TER (Total Expense Ratio): This is the ongoing expenses within an investment fund. 
• TIC (Total Investment Charge): 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 EAC, which was introduced by ASISA, gives investors a way to understand the full cost of holding an investment over time. The EAC combines various charges linked to an investment into a single annual percentage. It allows investors to compare the cost structures of different products and providers more easily.  Assuming all other factors are equal, a lower EAC may mean that a larger portion of your money remains invested and available to potentially grow. A higher EAC may place greater pressure on net returns as fees accumulate over time. Remember that costs should never be considered in isolation, as other factors play an important role too.  At 10X, you can expect fees that are low-cost, simple and transparent. Please visit our living annuity info page to see the living annuity-specific fee information.  

Fund selection for self-employed retirees 

Asset allocation is an important consideration for a self-employed retiree. As research indicates, asset allocation can be an important determinant of the growth of your capital over time. Asset allocation refers to the mix of different asset classes that your savings are invested in. These may be equities, real estate, bonds and cash. 

Equities may be included in a portfolio with the aim of long-term capital growth and potential inflation-beating returns. They provide exposure to companies and economic growth, but along with this may also come sizeable market declines. Value may move around substantially over shorter periods. This indicates that equities may be more appropriate for investors who are able to tolerate risk in their portfolio, along with those who have longer investment timelines. 

Real estate can be a good hedge against inflation. It also allows for exposure to both economic activity and real assets, while also generating income. It may help add long-term portfolio growth. Listed property can, however, be volatile and may be affected by the economy, interest rates, changes in the property market and occupancy levels.  

Bonds are usually less volatile than equities, but not necessarily risk-free. They can add diversification, income and some stability to your portfolio. Bond values can be affected by various factors such as changes in interest rates, inflation expectations and the ability of the issuer to repay its debt. While they’re seen as more conservative, they still may outperform expectations. 

Cash is the most stable and liquid of the asset classes. It is less likely to experience the same volatility that you may see with equities or real estate. The returns from cash may not keep up with inflation over long periods, which may then reduce purchasing power.  

You may also consider including some offshore exposure in your portfolio. This may provide greater exposure to a wider range of industries and businesses you may find in South Africa. This can improve diversification and reduce reliance on the performance of the local market and any local market volatility that may occur. Living annuities are not subject to Regulation 28 of the Pension Funds Act, which may mean there are no restrictions on exposure to equities and offshore investments, depending on the provider you choose.  

At 10X, you can expect to find a range of funds that are well-diversified across the different asset classes, allowing you the option to select a fund that suits your investor profile and long-term goals. To find out more about our funds on offer, please visit our funds page.  

What happens to your living annuity when you die? 

The first step is to make sure that you have nominated beneficiaries on your living annuity and that these are kept up-to-date, especially after any major life changes. Your nominated beneficiaries will receive the capital in the annuity when you pass away.  

Nominated beneficiaries will also be able to pass on any residual value to their own nominated beneficiaries. If you have not nominated a beneficiary, then the money may go to your deceased estate. This will then be paid out according to your testamentary wishes. This can often be a lengthy and costly process. Your living annuity may not be subject to estate duty if you have nominated beneficiaries. 

Transitioning to direct investment  

As a self-employed retiree, you may feel particularly comfortable about making your own financial decisions. Direct investing may, as such, be worth considering. Direct investing means managing your investment decisions without appointing a financial advisor to provide ongoing advice. This includes choosing your investment provider, choosing suitable funds, reviewing fees and monitoring your investments over time.  

One of the big benefits of direct investing is lower costs, as you’ll no longer need to pay advisor fees. This also means taking greater responsibility for your investment decisions, however. As such, understanding your income requirements, risk tolerance, investment timelines and long-term financial goals is key. You should also be comfortable reviewing your living annuity at least once a year to make sure that it still makes sense for your existing circumstances and goals. Don’t be misled, though. Direct investing doesn’t mean managing everything without any support.

At 10X, we provide clients with online calculators, transparent fee information and access to experienced investment consultants at no additional cost. We also have investment consultants ready and willing to answer all of your queries.  A few of the 10X tools we have available to help investors and retirees include:  

Living annuity calculator: Structure your retirement withdrawals effectively.  

Free cost comparison report: Compare providers to find cost-effective solutions.  

EAC calculator: Determine the total annual cost of managing your investment. 

Annual review checklist for self-employed retirees 

Reviewing your annuity at least once a year is an important part of managing your retirement income. Ideally, this should take place before your policy anniversary date, as changes to your drawdown rate generally need to be arranged in time for the next policy year.  As a self-employed retiree, your financial circumstances may change over time, especially if you keep earning income through consulting, business activities or other investments. An annual review provides an opportunity to assess whether your annuity still meets your income requirements, risk tolerance and long-term financial goals.   Here are some important questions to ask during your annual review:   

1. Have your income requirements changed? Consider any changes to your living expenses, healthcare costs or additional income sources.  
2. Is your drawdown rate appropriate and sustainable? Review whether your existing income withdrawals are placing too much pressure on your remaining savings. 
3. Are your fees reasonable? Consider the impact of investment management, administration and advisor fees on your long-term returns.  
4. Does your fund selection still suit your investor profile? Review your asset allocation, risk tolerance and long-term investment goals.  
5. Have your beneficiary nominations been updated? Make sure that they’re still reflecting your wishes, especially if you’ve had any major life changes recently.  
6. How has your investment performed? Review returns over the past year and consider performance in relation to your longer investment objectives.  
7. Has your tax position changed? Consider any additional income sources and how these may affect the tax payable on your annuity income.  

Final thoughts on living annuities for self-employed retirees 

A living annuity can suit self-employed retirees who want flexibility and control over their retirement income. Managing it carefully is essential to help ensure it remains sustainable and provides for you throughout retirement. Key factors to consider include your income needs, drawdown rate, fees, asset allocation, fund selection, beneficiary nomination, tax, and annual reviews.   Get in touch with the 10X investment consultants for any questions you may have about living annuities or other retirement products.