Living Annuities versus Guaranteed Annuities

As a member of a retirement fund (pension, provident, preservation or retirement annuity), you must use at least two-thirds of your fund proceeds to purchase an annuity. Only the following amounts are excluded from this requirement: your vested right – your provident (and provident preservation) fund balance on the date retirement reforms are implemented (1 March 2016) and subsequent returns thereon – and any fund balance (net of your vested rights) less than R247,500. If you are a provident fund member older than 55 on the date retirement reforms are implemented, your subsequent contributions to that provident fund are also exempt.

The annuity will provide you with a regular income for the rest of your life; you are not permitted to buy a fixed-term annuity that only pays out for a specific number of years. Your annuity income is taxed according to the personal income tax tables prevailing at the time.

You can choose between two types of annuities: a guaranteed annuity or a living annuity.

What is a Guaranteed Annuity?

The guaranteed annuity (GA) is an insurance product that you purchase from a life assurance company (Old Mutual, Sanlam, Momentum etc). The life assurer guarantees to pay you a specified monthly pension for the rest of your life. This effectively insures you against longevity risk (the risk that you live longer than expected) as well as investment risk (using up your money too soon due to poor investment returns).

This pension is paid until you die. The drawback is that your money dies with you, and no money passes onto your heirs. That is your risk: you (or, rather, your heirs) forfeit your savings in the event that you die sooner than expected.

You can, however, choose a guaranteed annuity that guarantees to pay for at least a certain number of years.  Or that will continue to pay your spouse (albeit a lesser amount).  But note that the more protection you want in your annuity, the less money you will receive every month.

Annuity rates (the pension that you receive) are variable and can differ from one life assurance company to the next. As you may receive a different income for the same amount invested, you should shop around for the best available rate at the time.

Life assurance companies consider a number of factors in determining your annuity rate:

1. Your age: the younger you are, the longer you are likely to live, and hence the lower your monthly pay-out.
2. Your gender: women have a higher life expectancy than men, on average, and therefore receive a lower pension.
3. Interest rates: the higher the prevailing interest rates, the higher your monthly pension is likely to be.
4. Your choice of annuity: you have a number of product options, with different risk profiles. The more insurance you require, the lower your annuity will be. In other words, an annuity that provides a guarantee or spousal benefit will pay out less than an annuity that does not.

What is a Living Annuity?

The living annuity is, in essence, an investment product. It transfers the risk and responsibility of securing an adequate income for life onto your shoulders. In return, you have greater investment and income flexibility and your nominated beneficiaries inherit whatever is left of your money after your death (ie your capital does not die with you).

With a living annuity, you decide how to invest your savings, within the basket of investments offered by your product provider. Unless you have the necessary investment expertise, you should consult a reputable retirement planning tool or financial advisor on the appropriate draw-down rate and asset allocation.

Living annuities are offered by banks, collective investment schemes (such as unit trust management companies), life assurance companies and registered pension funds, but are still classified as life assurance policies.

Living annuities are mainly sold through Lisps (linked-investment service providers). Lisps are essentially administrators who invest your money according to your instructions. They then track the performance of your investments. Lisps do not provide financial advice and you normally have to deal with them through a registered financial adviser.

Some providers, such as 10X Investments, offer their Living Annuity direct to the public. This enables investors to sidestep LISP and – if they choose – advisory fees.

Living Annuity Rules

Every year you must draw a pension from your investment. This so-called draw-down must be at least 2.5% but no more than 17.5% of the annual value of the residual capital at the policy anniversary date. Your draw-down rate can change from year-to-year, but you must make your election before the policy anniversary date. You can choose to receive your income monthly, quarterly, semi-annually or annually.

You can switch product providers, but you should do so only for sound reasons, such as an increase in costs, poor service or inappropriate investment choices. You are not bound to one annuity. Provided that one annuity has a minimum income flow of at least R150 000 per year, you can purchase up to four annuities with the proceeds from your pension fund.

You can switch a living annuity into a guaranteed annuity at a later stage (although you cannot do the reverse). You can take out both types of annuities concurrently or purchase a composite annuity (both living and guaranteed) under a single life assurance policy.

Your nominated beneficiaries inherit any residual capital after your death; they can choose to receive a lump sum, an ongoing annuity or an accelerated annuity (paying out over five years). If you do not nominate any beneficiaries, the money will fall into your deceased estate and be subject to your testamentary wishes.

Your living annuity is not subject to Estate Duty. Any residual capital is taxed either per the lump sum or the income tax table (depending on whether beneficiaries choose to receive a lump sum or annuity income).

Making your decision

A living annuity is riskier than a guaranteed annuity. The latter will pay you a regular income for the rest of your life. You have no such certainty with a living annuity – you assume the longevity risk (the risk that you last longer than your savings).

Costs are an important consideration with any investment, also for a living annuity. These products are potentially very expensive. Most living annuity charge initial fees, annual fees, transaction charges and investment management fees (on top of any advice and platform fees you may pay). In total, these charges can be as high as 2.5% pa of your capital. The 10X Living Annuity charges only one annual investment management fee, at a maximum of 0.86% pa (incl. VAT) of your capital (the fee drops for amounts above R5m).

In choosing between the different types of annuities, you must consider a host of factor specific to you: your health, age and life expectancy, how much you have saved, your desired income (lifestyle), your need for investment and income flexibility, the needs of a financially dependent spouse, potential bequests, relative investment costs, and, on a more subjective level, prevailing interest rates (which drive annuity prices), the inflation outlook and – if you have strong views on this subject – the investment outlook.

For example, if you retire young, a low-cost living annuity may serve you better than a guaranteed annuity as the latter will factor in your increased life expectancy and pay out less. But in your seventies, the guaranteed annuity is likely to pay out more, as your life expectancy has fallen. And if you are in poor health or terminally ill, you will probably need your money sooner rather than later. In that case, a living annuity with a flexible draw-down rate may suit you more. This also ensures that your capital does not die with you.

In other words, you must understand your needs and circumstances, and chose your annuity accordingly. To compare alternate options, you need to consult an appropriate retirement planning tool (such as the 10X Retirement Planner) and/or a financial advisor before making your decision.

Only obtain advice from a reputable financial organization, and separate the advice fee from the investment product you choose.