Retirement from a fund marks the shift from building capital to drawing an income from it. Choosing the most suitable annuity for your needs can be challenging, with a range of variables to consider before making a decision which including the following:
Cash withdrawal
At retirement, you may commute up to one-third of your retirement capital as a lump sum, and this amount will be taxed according to the retirement lump sum benefits table, with the first R550 000 being tax-free. Thereafter, you will be taxed on a sliding scale between 18% and 36%. Your decision to take a cash commutation will depend on several factors, including any previous withdrawals made, whether you need access to funds for immediate expenses or debt, and whether you have sufficient discretionary savings to provide liquidity in retirement.
Leaving a legacy
If leaving a financial legacy is important to you, a living annuity may be a suitable option. This is because a life annuity, being a life insurance policy, pays a guaranteed monthly pension until your passing, at which point the income ceases and the policy terminates. On the other hand, a living annuity is an investment held in the name of the annuitant and, upon death, the remaining capital can be bequeathed to one’s beneficiaries.
Your marital status
It’s essential to keep in mind that your marital status can influence your annuity choice, specifically when it comes to life annuities. A life annuity can be structured on a single or joint-life basis, allowing income to continue until the death of the last surviving spouse. It is also possible to choose a reduced income after the death of the first-dying spouse. On the other hand, the owner of a living annuity can bequeath the investment to the surviving spouse, who can then adapt the drawdown rate to their specific needs.
Your appetite for risk
A key difference between annuity types lies in who carries the investment risk. In a living annuity, the annuitant carries the risk that poor investment returns can erode the capital and income. On the other hand, the insurance company carries the investment risk of a life annuity while guaranteeing the policyholder an income for life. As such, your propensity for investment risk, especially later in life, should be taken into account.
Retirement capital
The quantum of your retirement capital also plays a pivotal role. Keep in mind that, to sustain your living annuity capital over time, a drawdown rate of about 4% per year is recommended. If your capital cannot support this level of drawdown, your investment may not be sufficient to last your lifetime, particularly if you retire early or are in good health with a long life expectancy. That said if you are in poor health or have adequate retirement savings, a living annuity may offer better value.
Financial needs of loved ones
As mentioned above, life annuities offer limited value to heirs unless specific income guarantees are in place. With a living annuity, any remaining capital can be bequeathed directly to beneficiaries and fall outside of one’s deceased estate, thereby making the funds more easily accessible to heirs while at the same time avoiding estate duty and executor’s fees.
Inflation protection
When selecting a life annuity, you will need to choose whether your income remains level, increases at a fixed rate per year, or is linked to inflation. A level annuity pays more initially but will likely lose purchasing power over time. On the other hand, annuitants can adjust their living annuity draw-down rates annually between 2.5% and 17.5% of the value of the residual capital, depending on their specific needs, meaning that inflationary risk rests with the annuitant.
Tax-efficiency and estate planning
Living annuities are highly tax-efficient estate planning tools in that growth in the annuity is exempt from tax on interest, dividends, and capital gains. Additionally, to the extent that the funds in a living annuity were a result of tax-deductible contributions, living annuities do not form part of one’s dutiable estate and are not subject to executor’s fees.
Ongoing advice
Living annuity investors typically require ongoing financial advice to manage drawdowns, adjust portfolios, and mitigate risk. While this adds an advice fee, these products generally offer greater transparency and flexibility.
Transparency and flexibility
Living annuities provide full visibility over investment choices, fund performance, and fees. Annuitants have the flexibility to adjust their investment strategies, switch funds, or change investment platforms without incurring penalties. Annuitants also retain the option to convert their living annuity to a life annuity at a later stage.
Offshore exposure
If offshore exposure is a priority, note that living annuities are not subject to Regulation 28 of the Pension Funds Act, allowing annuitants to invest up to 100% of their capital in offshore, Rand-denominated funds. This can provide a valuable hedge against local currency depreciation and geopolitical uncertainty.
* Tapfuma is a Certified Financial Planner professional at Crue Invest.
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