Two possible vehicles: the Living Annuity and the Life Annuity
Given how similar they sound, you’d be forgiven for assuming these terms both describe the same thing, but that’s definitely not the case. Let’s take a look at each annuity type in turn, and then also look at a third possible option: the hybrid annuity.
Living Annuities – how they work and the possible risk
These are still the most commonly used post-retirement income investments in South Africa. A living annuity works like this: the retirement funds that you have not withdrawn as a cash lump sum are transferred to an investment that requires an annual draw-down of the investment within a range of 2.5% to 17.5%. There are no restrictions on your chosen investment allocation; the investment is excluded from your estate and there are no executor’s fees applicable where you nominate a beneficiary.
The risk you face with a living annuity is… living too long. This is because you own and control the capital, so if you draw that capital down at a faster rate than is reasonably sustainable, you will deplete the living annuity investment too soon.
So, what else can you do? At some point, a life annuity could become a suitable option. You can approach an assurance company for a life annuity quote at any point during your retirement as an alternative to personally managing your longevity risk.
Life Annuities – how do they work and what’s their risk?
A life annuity is a product rather than an investment and the purchase of a life annuity gives you a guaranteed monthly income, regardless of how long you live. When you implement a life annuity, you transfer your capital (along with the longevity risk you would otherwise be managing personally) to an assurer. In exchange for that capital, they contract to pay you monthly, usually with annual increases for the rest of your life (or both your life and your spouse’s life, if applicable).
With a life annuity, the only possible risk is that your agreed annual income increase falls behind future inflation rates, resulting in reducing disposable income over time. This possibility is something you should assess during your decision process.
The downside of the life annuity is that you no longer have the ability to temporarily increase or decrease your income. Also, you will have given away the capital which will not pass on to your heirs on your death.
Now, where does a Hybrid Annuity fit in?
Until recently the living annuity or life annuity were the only options available. Fortunately, recognising the need for something in-between, the investment industry has evolved to now provide for hybrid annuities.
The result is that now, a portion of your living annuity can be used to purchase a life annuity within a living annuity investment vehicle. Within this hybrid annuity, you retain your rights to adjust your income draw annually within the range of 2.5% to 17.5% of the investment value. However, your full investment is no longer subject to market movements, because part of it is a monthly income payment of the life annuity portion that was purchased.
In rare cases where the life annuity portion paying into your hybrid annuity exceeds the amount you draw each month, you will be in an enviable net monthly income position where your investment and value actually increases despite you drawing down the capital.
Life annuity rates vary over time, because movements in interest rates and bond yields have an impact on them. Factors of gender and age also play a role however, the most notable recent change has been the medical underwriting that some assurers apply. This, tied in with life expectancy can enhance the standard quoted life annuity income.
Decisions, decisions… What option will suit YOU?
As always, there is no one-size-fits-all recommendation. Retirement funding is a journey and your needs will vary depending on your individual circumstances. If you are approaching 55, ask your CERTIFIED FINANCIAL PLANNER® professional about post-retirement income options at your next annual review.
By Gareth Leonard, CFP® CA(SA)
