When retiring from your pension, provident, preservation or retirement annuity fund, legislation requires that you use at least two-thirds of your investment to purchase an annuity income, which is effectively a pension income payable on a regular basis during your retirement years. Many retirees, facing this all-important juncture, find the available options and subsequent decision-making overwhelming and complex – especially as many of the decisions are irreversible. Before purchasing a living annuity, our advice is to fully understand what you are signing up for. Here’s what to know.
A living annuity is an investment
Living annuities are governed by the Long-Term Insurance Act but, unlike life annuities, are actually investments linked to unit trusts, cash investments or share portfolios held in the name of the annuitant. Because it is not an insurance policy, the living annuity does not insure the annuitant against investment risk nor against longevity. There is no age limit for purchasing a living annuity, although the earliest you will be permitted to retire from a retirement fund is age 55, meaning that a living annuity structure is available from this point onwards.
Once the funds have been set up in the living annuity structure, the annuitant is obliged to draw a regular income on a monthly, quarterly, or annual basis, and the onus of ensuring that they don’t run out of capital rests with them. Being an investment, it is important to bear in mind that a living annuity offers no guarantee on your capital which is linked to investment performance and, as such, selecting an appropriate investment strategy is key to sustainable cashflow in retirement. Further, when choosing a living annuity, it is essential that you pay particular attention to the fees that you will be charged as this will ultimately impact your capital and your drawdown.
You can choose your underlying investments
Once you have used the proceeds of your retirement funds to invest in a living annuity, your funds are no longer subject to the constraints of Regulation 28 since a living annuity is not governed by the Pension Funds Act. This effectively means that, as an investor, you have complete freedom as to how the underlying investment portfolio is structured. This means that you can customise a portfolio that is fully aligned with your investment objectives, risk profile, and investment horizon. The mix of assets that you choose in your underlying investment portfolio will determine the expected long-term returns of your portfolio together with the amount of volatility you can expect to experience.
If desired, you can elect to invest 100% of your assets offshore, bear in mind that this will need to be done using a rand-denominated offshore feeder fund as living annuity investors cannot invest directly offshore using foreign-domiciled funds. Living annuities provide investors with a broader range of investment opportunities that can enable them to beat inflation and generate an income in their retirement years, although it is important to mitigate the risks of inflation and outliving your capital when structuring your living annuity.
Drawing from your living annuity
Living annuity investors are required to draw an income of between 2.5% and 17.5% of the residual capital per year, with the ability to adjust the drawdown rate annually on the policy’s anniversary. Setting the drawdown rate at a level that is sustainable into the future is critical, and this is best determined with the guidance of a retirement planning expert. Detailed cashflow projections will help determine the most appropriate drawdown level, keeping in mind that increasing your withdrawal rate will make it harder for your investment to keep pace with inflation over time.
Remember, during your lifetime, you cannot access the capital in your living annuity through ad hoc withdrawals, you are limited to your annually selected income, although the market value of your investment at the time of your death will pass to your nominated beneficiaries. The only exception to this is where the balance in your living annuity is below R125 000, in which case a full withdrawal is allowed. Because you cannot make lump sum withdrawals from your living annuity, it is important that you make arrangements for an emergency fund using discretionary money.
Additional contributions to your living annuity
Once you have a living annuity in place, you are permitted to make additional contributions towards your investment provided that the funds are from an approved retirement fund. For instance, if you later decide to retire from a retirement annuity, you can elect to transfer the benefits into your existing living annuity structure.
Tax and your living annuity
The funds held in your living annuity will not attract dividends tax, CGT, or income tax, although once you begin drawing an income from the fund, this income will be taxed at your marginal tax rate.
Your living annuity in the context of estate planning
Living annuities make excellent succession planning tools for a number of reasons. Firstly, unlike life annuities which terminate on the death of the policyholder, when the annuitant dies, the funds remaining can be used to provide a financial legacy for your loved ones. Secondly, unlike the case of retirement fund beneficiary nominations which are regulated by Section 37C of the Pension Funds Act, annuitants are free to nominate beneficiaries as they wish, with the assurance that those nominated will receive the funds in the event of death. Thirdly, where the annuitant has nominated a beneficiary, the proceeds of the living annuity will not form part of the deceased’s estate, and will therefore not attract estate duty or executor’s fees. As such, before taking out a living annuity, it is important to take into account the financial needs of your spouse and/or loved ones should you pass away and ensure that your estate is structured accordingly.
Where you have nominated beneficiaries to your living annuity, they have the option of transferring the living annuity into their own name or taking it as a lump sum. Lastly, bear in mind that the capital in your living annuity is protected from creditors and cannot be attached by means of a court order. However, the income drawn from your living annuity is not subject to the same protection.
Emigration and living annuities
If you emigrate subsequent to setting up your living annuity, keep in mind that you cannot transfer your living annuity abroad. The investment will remain in South Africa and the income drawn must be paid into a South African bank account, which you can then convert into a foreign currency of your choice.
Transferring your living annuity
Living annuities are very flexible investments in that they allow investors to change local investment platforms and the underlying strategy with no tax or cost implications.
Converting your living annuity to a life annuity
Legislation permits annuitants to purchase a life annuity with their living annuity capital should they wish to do so at a later stage. However, once a life annuity has been set up, it cannot be converted to a living annuity.
The decision to purchase a living annuity is something you are likely to make once in your life, and it is absolutely essential to get it right. Rather than trying to navigate this complex area of retirement planning alone, consider seeking the advice of an experienced, fee-based financial advisor.