Choosing between a life annuity and a living annuity

When reaching retirement, we’ll almost all be faced with the choice of taking either a guaranteed annuity (also known as a life annuity) or a living annuity.

Irrespective of other investments, if you are 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 at retirement. This annuity will provide you with a regular income (or pension) for the rest of your life.

It’s not an easy decision and thankfully not limited to just one or the other. You can take out both types of annuities concurrently or purchase a composite annuity (both living and guaranteed) under a single life assurance policy, which is a bit of a hybrid product.

A guaranteed annuity or life annuity

The guaranteed annuity is an insurance product that you purchase from a life assurance company. The life assurer guarantees to pay you a specified monthly pension for the rest of your life, which effectively insures you against the risks of living longer than expected, as well as the risk of using up your money too soon.

On retirement, you would purchase the annuity by paying a lump sum in exchange for the guaranteed monthly income, which would normally include an annual increase.

Several factors to consider when determining your monthly pension include:

1. Your age – the younger you are, the longer you are likely to live, which results in a lower monthly payout.
2. Your gender – women have a higher life expectancy than men and generally 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 – depending on the exact product and benefits you opt for, the payout will vary. The more insurance you require, the lower your annuity will be.

Pros

You’ll receive a guaranteed monthly pension for as long as you live.

Cons

With this product your money dies with you and no money passes on to your heirs.

A living annuity

The living annuity is an investment product. You invest your money and can withdraw a monthly (or annual) pension that suits your needs. You do, however, need to work within the confines of the prevailing regulations.

Pros

You have far greater flexibility in terms of investment choices, and can decide on the monthly income required. Should you have money left in the fund after your death, this will be passed on to your nominated beneficiaries. Overall you have more control of your investment.

Cons

The risk of a living annuity is that you may run out of funds and be left with no pension. This could be due to poor performance in the markets, withdrawing too much for your living expenses, or simply by living longer than expected.

Some points to note

• Living annuity investors are currently not subject to Regulation 28 of the Pension Funds Act, which means that there are no prescribed investment limitations as in the case of a retirement annuity investment.

• You must draw a pension from your investment every year; at least 2.5% but no more than 17.5% of the annual value at the policy anniversary date. The annual withdrawal is unfortunately not an ad hoc amount, as you need to specify the draw-down rate prior to the policy anniversary date.

• You can switch product providers, and are not bound to one annuity. Provided that one annuity has a minimum income of at least R150,000 per year, you can purchase up to four annuities with the proceeds of your pension fund.

• Your nominated beneficiaries inherit any remaining capital after your death and can choose to receive a lump sum, an ongoing annuity or an accelerated annuity (paying out over five years). This is not subject to estate duty, and is taxed either as a lump sum, or per the individual income tax tables.

Making your decision

It’s not an easy decision to make. On the one hand you have a guaranteed pension for life, but it does not transfer to your heirs. On the other hand you have a more flexible investment that passes over to your beneficiaries, but you stand the risk of running out of money.

You should consider a host of factors specific to you:

• your health, age and life expectancy
• existing investments
• current income streams
• the needs of your dependants.

You should also consider where you plan to retire, how much you need to live on, and – more subjectively – your investment outlook for the country.

If you plan to retire young, you should consider a low-cost living annuity as your age will be factored against you in a guaranteed annuity. If you’re older, though, say in your seventies, the guaranteed annuity may be a better option as your life expectancy is less, and your monthly annuity will likely be more. You may also need your money sooner rather than later due to ill health or other circumstances, in which case a living annuity with a flexible draw-down rate may suit you better.

There is no specific formula to apply when making this decision, so it’s always best to discuss it with a trusted financial advisor. As a final thought, you can switch a living annuity into a guaranteed annuity at a later stage if you change your mind – but you can’t do the reverse.