Retirement comes with two pressing financial challenges: How best to ensure a reliable income and how to make your capital last as long as possible.
Ideally your retirement planning should be so precise that you spend your last cent on the day you die, but without the advantage of a crystal ball an annuity steps into the breach to help you manage your income expectations for the duration of your life by paying out regular disbursements.
A living annuity is a flexible product which enables you to adjust the income you draw without incurring any penalties. What you put in and the performance and management of the investment over time is, quite literally, what you get out.
How much you are able to transfer into a living annuity upon retirement depends on how diligent you have been during your life and how much you have accumulated in your retirement annuity, pension or provident fund. Ideally, if you project you will retire at 65, you should work on drawing an income for at least 30 years thereafter. If you plan to retire at 55, then your savings may need to keep you in the manner to which you’ve become accustomed for 40 years or more. So much depends on your approach to retirement saving over the course of your life.
How does a living annuity work?
In South Africa, it is legally required that, on retirement, you use at least two-thirds of your retirement fund to buy an annuity.
It’s at this point that you will have to make a choice between a living annuity or a life annuity. The big difference between the two is that a life annuity will pay a predefined amount until you die, regardless of market movements, while a living annuity is subject to the performance of the underlying assets.
This can be seen as a risk for the living annuitant since it requires careful planning when it comes to determining the drawdown (or withdrawal) rate, and other issues must also be taken into account, like external pressures such as inflation, the performance of the markets and how long you live. Getting expert help to manage your living annuity is, therefore, advisable.
What if I opt for a life annuity?
A life annuity, meanwhile, gives you the option to select a guaranteed income over a specified period. The attraction of a life annuity is that the risk shifts from the annuitant to the insurance company in that you are assured of a set annual increase and the guarantee of an income for life – no matter how long that proves to be. You also need to trust that the company in question will be around and in tip-top financial shape for the 20, 30, 40 or more years of your retirement.
With a life annuity any capital remaining will not be transferred to your beneficiaries on your death and, unlike a living annuity, a life product annuitant also doesn’t benefit from market boom times – but nor are they impacted by market dips and recessions.
Managing your living annuity
For those selecting a living annuity, certain rules do apply. This includes the stipulation that you draw a pension income of between 2.5% and 17.5% a year (based on the value of the capital in the annuity). This can be drawn each month or on a quarterly, twice-yearly or annual basis. Generally, in order to ensure that you have the necessary funds to ensure an income over your lifetime, the amount you draw each year should be under 4% of the annuity’s value each year. If you draw too much, and too soon, then your income later in life could be negatively affected.
A living annuity is not subject to pension regulations, meaning you can invest up to 100% offshore if appropriate. This has been a driving force in recent years as investors have been wanting more than the 30% currently allowed. Another advantage of a living annuity is that, upon your death, the annuity does not form part of your estate, which means the capital does not attract estate duty. This makes a living annuity a handy estate planning tool which gives your nominated beneficiaries almost immediate access to the remaining funds.
Active management is the key
Given the different benefits and risks associated with your two annuity choices on retirement, it is becoming increasingly prevalent to see a mixture of life and living annuity uptake by retirees. In South Africa, due to certain restrictions, it is advisable to carefully structure your retirement nest egg to make provision for the possibility of moving a living annuity into a guaranteed life annuity as you get older, possibly around 70 or 80 (you can only shift funds from a living annuity to a life product, not the other way around). This may require taking out more than one living annuity on retirement to ensure you stay on the right side of current regulation.
“For many individuals stepping into retirement the choices facing them at this time can be daunting,” says Anthony Palmer, Group Commercial Director at Carrick Wealth.
To help you navigate these critical decisions, Carrick Wealth suggests working closely with a professional who can guide you through the process, help you navigate the regulatory implications and manage your expectations for the future. “Ideally, this discussion begins well before these choices have to be made, and forms part of a long-term and robust retirement strategy,” says Palmer.