How a Living Annuity Works

When you retire from a retirement fund such as a pension, provident, preservation or retirement annuity, you can invest all or part of your money in a living annuity to get a regular income. You can adjust your living annuity income annually and choose how your money is invested.

Alternatives for investing the proceeds of your retirement fund are a life annuity or a capital protector. You can invest in a combination of these options, if the rules of your retirement fund permit. Each of these different types of compulsory annuity options has unique features suitable for different needs. Here’s how a living annuity works.

Living annuity basics:

• At retirement, you instruct your retirement fund to transfer all or part of your fund balance to the living annuity of your choice.
• You decide which investment funds to invest in within the living annuity. You should do this with the help of a qualified financial advisor.
• You can change the underlying investment funds in your living annuity whenever you wish by switching between the fund options. You can also hold a mix of funds at the same time and some living annuities allow a personal share portfolio as the investment fund.
• You decide how much income you want and the frequency of payment within upper and lower income limits. Here’s how the income works:
  • Over a year, your income may not exceed 17.5% of the starting balance in the investment and it may not be less than 2.5%.Your income can be paid monthly, quarterly, twice a year or annually.
  • At every anniversary of the start date of the Living annuity you can change the income amount and payment frequency within these limits, using the fund balance at the anniversary to calculate the income percentage.
• You can nominate beneficiaries to receive the balance in the fund when you die:
  • Your beneficiaries can take their share as a lump sum, which may be subject to tax, or they can transfer to a new living annuity with their own choice of income and investment funds.
  • There is no estate duty on the proceeds of living annuities and if you nominate a beneficiary, they are paid directly from the investment at your death. This avoids the delay and cost of funds being processed via the estate accounts.

The living annuity focuses on income flexibility and investment choice with capital balance transferrable at death. This contrasts with the goal of the life annuity, which is a guaranteed income for life and the capital protector, which is guaranteed income for life, with original capital invested refunded at death.

The focus on flexibility in the living annuity is a trade-off against the guaranteed income for life offered by the other options. If the income you draw is higher than the growth in your chosen investment funds, you use up your capital and you can run out of money too early, so managing your income draw and monitoring your investment growth regularly is an important part of owning a living annuity.

Managing your living annuity.

Managing your income

• While there are no guarantees in investing, research shows that if you draw an income of no more than 4% you have a high probability of your income lasting throughout your retirement.
• You must consider inflation. To be able to increase your income in line with inflation and preserve your capital in real terms, you need to get enough growth to grow your capital by the same amount as inflation plus the amount you draw as income. So, if inflation is 5% and you take 4% income, you need 9% growth to sustain your income. For example:
  • You have R100 000 capital and your yearly income at 4% is R4000.
    • In a years’ time, you want your income to increase by 5% to R4200 cover inflation. So, you need to get 4% growth to cover your income plus 5% growth to offset inflation.
    • After a year you’ll have R105 000 and your income at 4% will be R4200.
• You do not need to preserve your original capital balance throughout retirement to keep getting the income you need. If your capital can last long enough to keep your income going for your lifetime, it’s fine for your capital to start reducing.
• If your income exceeds your growth, the investment balance reduces. This means that every year, even to get the same income, you must increase the percentage of your income in relation to the investment balance. Once it reaches 17,5% the income cannot be increased. The investment balance will reduce every year because you won’t likely get investment growth of more than 17.5%. At the anniversary, the income for the following year will stay at 17.5% but calculated on a lower investment balance so your income reduces annually.
• A useful feature is that you can transfer part or whole of your living annuity balance to a Life annuity at any time up until age 75. This allows you to lock in a higher guaranteed income for life. This is because Life Annuities offer more income for a given investment amount when you are older and because you can time the transfer to a life annuity so that you do it when annuity rates are at a high. It may be good planning to start with a living annuity for maximum flexibility in your early retirement years and make a part or full transfer to a life annuity later for a guaranteed lifelong income in the latter years.

The flexible option

The living annuity is attractive because it offers flexibility, but if that flexibility is used without the necessary care, it becomes a disadvantage.

Many people choose the living annuity because they want to leave capital to their children at their death, and they don’t like that life annuities do not pay capital at death. But then they end up using their living annuity capital up too soon and instead of leaving them an inheritance, they become a burden to their children.

Who should consider investing in a living annuity?

Here are some situations where a living annuity may be a suitable choice:

• If you can draw 4% or less annually of your retirement savings and have enough income to live on, then consider a living annuity.
• If you are comfortable with some investment risk and happy working with a financial advisor to decide on investment allocations and income changes, a living annuity may suit you.
• If you are in a situation like early retirement or retrenchment, where you must decide how to invest your retirement funds immediately, but you expect that your income needs might change then consider a living annuity.
• If you have a serious illness, and there is the likelihood of some years having much higher expenses, or a high probability you might die at a younger age than average, a living annuity may suit you.
• If you have emigrated you can use the maximum draw of 17.5% to “drain” the fund over a few years. When the balance goes under R125000 (As at 2024 tax year), you can take the balance as a lump sum.

In conclusion

Living annuities offer flexibility, control, and a legacy, but getting the full benefit of this investment option requires consistent and level-headed management; it’s not something you can sign-and-forget. If you choose this option, you should make sure to partner with a financial advisor who has a disciplined approach to providing ongoing advice and support.