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As you get closer to your expected retirement date, one can often be overwhelmed by information and have difficulty making important retirement decisions. Certain decisions include selecting how much to draw as a lump sum, choosing the right product, how much income to draw and where to invest your retirement savings.
Investors will commonly transfer their retirement savings to a living annuity investment. But to benefit most from a living annuity, it must be incorporated within your retirement plan correctly to ensure that you achieve overall tax-efficiency, have enough liquidity in life and death, and follow the correct investment strategy.
We have detailed the key attributes of a living annuity and answered some important FAQs such as the difference between a living annuity and other retirement products. Please read below.
What is a Living Annuity?
A living annuity (LA) is a post-retirement vehicle that provides you with an income at retirement from the proceeds of your retirement funds.
It is a flexible investment that allows you to choose the income that you receive while investing in selected underlying investments (such as unit trusts) to grow and preserve your capital investment.
What are my income options?
Living annuities do not guarantee an income for life. You need to select an income percentage that could sustain you for your preferred lifestyle. You must draw an annual income between 2.5% and 17.5% (subject to current limits set by legislation) of your investment value.
This percentage may be adjusted annually on the anniversary date of the investment contract. Income may be paid monthly in arrears, quarterly, half-yearly or yearly in advance.
Income may be withdrawn from all underlying investment options, or a portion of the capital can be allocated to specific funds, from which income is drawn.
Calculate your retirement needs here: https://www.investonline.co.za/calculators/i-am-retired/
What are the benefits of a living annuity?
- You have the option to choose the underlying investments to grow your capital and provide income.
The flexibility of your choice of income allows you to increase or decrease the income drawdown subject to the ASISA standards. - At death, the investment value is not forfeited but can continue to be paid out as income or in cash to a nominated beneficiary/ies.
What are the risks involved?
- The income you choose to draw from your living annuity may be too high, causing your capital to reduce over time. This means that your future income could fail to keep pace with inflation or even that you outlive your investment.
- Choosing your own investment portfolio brings inherent risks. Your investment value and returns are not guaranteed and may move up or down. The value of your investment account depends on the market value of the underlying investments. If markets fall or returns are poor, then your capital could reduce or fail to keep pace with inflation.
What is a living annuity’s investment term?
This contract is for life. On death, the remaining benefit may be paid to your beneficiaries as an annuity, or it can be commuted (the income can be exchanged for a taxable cash lump sum).
How is a living annuity taxed?
Your annuity income is taxed at your marginal income tax rate and based on the total income you receive. The growth, interest and capital gain earned within the living annuity is exempt from tax.
What happens to the money when I die?
The death benefit from a living annuity is paid out to your nominated beneficiary/ies and can be taken as a lump sum payment, transferred to another living annuity or a combination of both. If there are no beneficiaries nominated, the living annuity will pay out as a lump sum to your estate.
What options do my beneficiaries have after my death?
- They can continue with the annuity and receive the income but will be taxed on that income at their marginal tax rate.
- Take out the investment value in cash, which is taxed in the hands of the deceased (as per retirement tax tables up to 36%).
- They can elect to take a combination of a cash withdrawal (subject to retirement tax) and an income option.
What is the governing legislation?
The Retirement Income is regulated by various laws, including the Long-term Insurance Act, the Financial Advisory and Intermediary Services Act and the Income Tax Act. The underlying unit trust funds are regulated by the Collective Investment Schemes Control Act.
How is a living annuity treated on insolvency?
In terms of current legislation, your benefit is protected in the living annuity should you become insolvent.
How do I select the right income drawdown?
When drawing a regular income from your investments, it is important to start with an income that can increase with inflation but does not erode a growing capital base which is necessary to support higher income levels over time. Drawing interest only is not a good starting plan as neither your investment nor your income can adjust with inflation over the longer term.
The table below provides a rough guide as to how long (in years) a R10m living annuity can provide an income before you reach the maximum 17.5% income cap, and your income starts to reduce. The table provides different periods depending on different starting incomes and above inflation returns (inflation +). The income is assumed to increase by inflation every year.
| Monthly income on R10m (before tax) | Annual Drawdown | |||||||||
| 0% | 1% | 2% | 3% | 4% | 5% | 6% | 7% | |||
| R33 333 | 4.0% | 20y | 23y | 29y | 39y | 40+y | 40+y | 40+y | 40+y | |
| R35 000 | 4.2% | 18y | 22y | 26y | 35y | 40+y | 40+y | 40+y | 40+y | |
| R40 000 | 4.8% | 15y | 18y | 21y | 26y | 36y | 40+y | 40+y | 40+y | |
| R45 000 | 5.4% | 13y | 15y | 17y | 21y | 27y | 40+y | 40+y | 40+y | |
| R50 000 | 6.0% | 11y | 12y | 14y | 17y | 21y | 27y | 40+y | 40+y | |
| R55 000 | 6.6% | 10y | 11y | 12y | 14y | 17y | 21y | 29y | 40+y | |
| R60 000 | 7.2% | 8y | 9y | 10y | 12y | 14y | 17y | 21y | 32y | |
| R65 000 | 7.8% | 7y | 8y | 9y | 10y | 11y | 13y | 17y | 22y | |
| R70 000 | 8.4% | 6y | 7y | 8y | 8y | 10y | 11y | 13y | 17y | |
| R75 000 | 9.0% | 5y | 6y | 7y | 7y | 8y | 9y | 11y | 13y | |
The chart below provides an example of how long your living annuity can provide a regular income before you reach the 17.5% maximum income cap. The chart is modelled around a living annuity of R10mil, providing a monthly income of R 50 000 (increasing by inflation) achieving an investment return of 4% above inflation.
As seen above, after 21 years the maximum income cap of 17.5% is reached after which the maximum allowable income will continue to decrease into the future.
Calculate your retirement needs here: Saving for Retirement? | Retirement Calculator | Investonline
What are the key differences between a retirement annuity and a living annuity?
A retirement annuity, pension fund or provident fund are vehicles that are used to save for retirement. A living annuity is an investment vehicle that provides an income in retirement. Current regulations allow investors to convert their retirement annuity, pension fund or preservation fund to a living annuity from the age of 55.
Here is a summary of some of the key difference between a retirement annuity and a living annuity:
| RETIREMENT ANNUITY | LIVING ANNUITY | |
| Tax treatment | Capital growth and interest earned is exempt from income tax. | Capital growth and interest earned is exempt from income tax. Income withdrawn is taxed as per normal income tax tables (PAYE). |
| Income to be drawn | No income can be withdrawn. | Income between 2.5% and 17.5% of the investment balance must be withdrawn. This can be drawn once per year, twice per year, quarterly or monthly. |
| Offshore investment allowed | Maximum offshore investment of 45% permitted. | No limit to offshore investment permitted. Up to 100% of investment value can be invested offshore. |
| Beneficiary nomination | Yes | Yes |
| How beneficiary nomination is handled | Nominated beneficiaries are considered a guideline to the trustees of the fund. The trustees of the fund will determine the dependants of the investor and distribute the balance of the fund at their discretion. | A beneficiary nomination is executed as per the investor’s wishes. There is no trustee’s discretion. |
| Tax treatment on death | Once the trustees of the fund determine the dependants of the investor, the dependants can elect to withdraw their benefit as cash or transfer the benefit to a living annuity in their own names. Any cash lump sum withdrawn will be taxed as per retirement tax tables, up to a maximum rate of 36%. This tax is withheld by SARS. | The nominated beneficiaries can elect to withdraw their benefit as cash or transfer the benefit to a living annuity in their own names. Any cash lump sum withdrawn will be taxed as per retirement tax tables, up to a maximum rate of 36%. This tax is withheld by SARS. |
What is the difference between a living annuity and a life annuity?
Life Annuities provide you with a guaranteed income for the rest of your life (based on the initial amount invested) and are usually dependent on the prevailing interest rates at the time. Inflation risk is a concern, depending on the annuity income escalation selected.
Here is a summary of some of the key difference between a living annuity and a life annuity:
| LIVING ANNUITY | LIFE ANNUITY | |
| General characteristics of the investment | The longevity of capital invested in a living annuity is not guaranteed.
The investor needs to draw a minimum of 2.5% p.a. and can draw a maximum of 17.5% p.a. as income. The investor can change their income once a year on the anniversary of the investment. The longevity of capital is dependent on the income drawn and the underlying investment strategy. |
The longevity of the income is guaranteed.
There are different types of life annuities meaning that your starting income can be different dependent on future escalations. The investor can purchase a life annuity for themselves or for themselves and a partner to receive income after their death. The investor can also guarantee that the income will be paid to a beneficiary for a certain period should they pass away. |
| Investment Strategies | A living annuity is not regulated by Regulation 28 of the Pension Funds Act. Therefore, a client can invest in a pure Equity fund, an Offshore fund, etc. | When investing in a life annuity, an investor can purchase different future escalations which will impact the starting income. Certain options are highlighted below:
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| General Tax Implications | All income drawn from a living annuity is taxable in the hands of the investor and PAYE is applicable. There is no tax on the growth of the funds held within a living annuity.
A living annuity is not included in the Estate of the deceased, the owner can nominate a beneficiary (Or beneficiaries) who has options with regards to how they wish to access/invest the benefits they are inheriting. |
All income paid from a life annuity is taxable in the hands of the investor and PAYE is applicable.
The income from a life annuity ceases on the passing of the investor or the partner (joint life annuity, ceases on last dying), unless within the guarantee period purchased. |
| Other | A living annuity can be converted to a life annuity at any point in the future. | Once a life annuity is purchased, it cannot be converted into a living annuity. |
Pros of a Life Annuity
- No stock market risk.
- No risk of running out of capital or income decreasing into the future.
- Income can be set with a guarantee period to pay to the nominated beneficiary. However, this option reduces your starting income.
Cons of a Life Annuity
- Capital is forfeited to the insurance company on taking out the life annuity.
- The risk of an annual increase in income being less than inflation.
- A Life Annuity does not allow for investing offshore.
Investonline can help you
Our team of Client Portfolio Managers can help you with the difficult decisions that go with planning for retirement. Each individual’s retirement plan is unique and therefore there are many factors that need to be considered:
- Should you preserve your retirement funds or draw a portion as a lump sum?
- How should you structure your income to be tax efficient?
- What investment vehicles are right for you?
- What is the best investment strategy to follow?
Please contact us or send us an email at info@investonline.co.za and a Client Portfolio Manager will contact you shortly.
