Retiring from a retirement fund marks the shift from accumulating savings to drawing an income. Choosing the right annuity for your unique circumstances can be complex, with numerous factors and variables to consider. This decision requires careful evaluation to ensure your retirement capital effectively supports your financial needs and goals.
Should you take a cash withdrawal?
One of the first decisions to make is whether or not to commute up to one-third of one’s retirement savings. At retirement, investors can choose to withdraw one-third of their invested capital, which will be taxed according to the retirement lump benefits table, with the first R550 000 being tax-free, whereafter the withdrawal will be taxed on a sliding scale between 18% and 35%. The remaining two-thirds of the investment must be used to purchase an annuity income. Alternatively, investors can use the full amount to purchase an annuity income. There are a number of factors that should be taken into account when deciding whether or not to make a cash withdrawal, including your debt levels, capital needs in retirement, and whether you have sufficient discretionary funds to provide liquidity throughout your retirement.
Do you want to leave a financial legacy?
If leaving a financial legacy for your loved ones is important to you, you may favour the idea of a living annuity as opposed to a life annuity. A life or guaranteed annuity is an insurance policy purchased from a life insurer that pays the policyholder a monthly pension for the remainder of life. Upon the policyholder’s death, the policy terminates, and no further income is paid. While policyholders can add a guarantee period to a life annuity, which allows a beneficiary to receive an income for a pre-determined period of time, note that this ultimately affects the level of income payable by the insurer. On the other hand, a living annuity – being an investment held in the name of the annuitant – allows investors to leave a financial legacy for their loved ones in that, in the event of the annuitant’s death, the funds remaining in the investment can be bequeathed to nominated beneficiaries. A living annuity is therefore appropriate for those wanting to leave a financial legacy.
What is your propensity for risk?
One’s propensity for risk is an important determinant when selecting a retirement income, especially when it comes to investment and inflationary risk. It’s important that those retiring understand that a living annuity is an investment, meaning the annuitant assumes all investment risk. Poor investment returns can significantly affect the amount available to draw from the annuity, and investors should be prepared for such eventuality. In contrast, life annuities present no investment risk to the policyholder as all investment risk is borne by the insurer, who invests the money and pays the policyholder a set income in accordance with the policy contract. When choosing between a life annuity and a living annuity, carefully consider your willingness to take on investment risk, especially later in life. Assessing your financial goals, risk tolerance, and retirement needs will help determine which option offers the best security and peace of mind.
What is the value of your retirement funds?
The amount of capital you have at retirement is also a factor in determining which annuity vehicle is most appropriate for your needs. According to the Actuarial Society of SA Convention 2019, many South Africans choose to invest in living annuities even though they don’t have sufficient retirement capital to warrant their use. To ensure that annuitants retain their capital indefinitely in real terms, the recommended draw-down rate from living annuities is approximately 4% per year. If you do not have sufficient invested capital to draw down at this level while covering your income needs, the funds in your living annuity could be depleted prematurely, especially if you’re relatively young and healthy when you retire. On the other hand, if an annuitant is ill, has a shortened life expectancy, or has sufficient capital to draw down at a sustainable level until death, then a living annuity should definitely be considered.
Financial needs of loved ones
The financial needs of your loved ones in the event of your death are other factors to consider, keeping in mind that a life annuity terminates on the death of the policyholder, leaving no financial benefit for the heirs. Conversely, if you are well-funded for retirement and your capital will allow you to draw down in a sustainable manner using conservative death assumptions, your beneficiaries will stand to inherit whatever capital is left in a living annuity. Further, living annuities do not form part of a deceased estate, which means that your beneficiaries will have almost immediate access to these funds following your passing.
Do you appreciate inflationary risks?
When purchasing a life annuity, you can choose up front the manner in which your annuity income will increase. Generally speaking, policyholders have the option to choose a level annuity that offers no annual increase, bearing in mind that, while offering a higher income initially, this will result in your purchasing power decreasing in value as a result of inflation. You can also choose to link your annuity to inflation or set a pre-agreed annual increase. On the other hand, investing in a living annuity means that the risk of inflation lies with you, and you will have the opportunity to adjust your draw-down levels on an annual basis depending on your income needs, keeping in mind that you can draw down at a minimum of 2.5% and a maximum of 17.5% of the residual capital yearly.
What are your estate planning goals?
An important factor to consider is that living annuities make excellent estate planning tools and are tax-efficient. This is because any growth in the annuity is not subject to the taxation of interest, capital gains, or dividends. Further, living annuities fall outside of the deceased’s estate and are not estate-dutiable, nor do they attract executor’s fees. Therefore, from an estate planning perspective, living annuities can be effectively used to reduce costs if required.
What about offshore exposure?
If offshore investment exposure is important to you, keep in mind that living annuities are not subject to Regulation 28 of the Pension Funds Act, which means that you can choose to invest 100% of your capital in an offshore, Rand-denominated fund as a hedge against depreciating local currency.
How does your marriage contract affect your choice?
Your marital status will also play a role in choosing an appropriate annuity income. Most life annuities can be purchased on a single life or joint life which means that the annuity continues to pay until the death of the last surviving spouse. The annuitant can also select to have the annuity decrease on the death of the first-dying spouse to account for the reduction in living expenses. If your retirement capital is invested in a living annuity, you can simply bequeath the investment to your spouse, following which they will be able to continue drawing down from the investment in accordance with their needs.
Choosing the right annuity is pivotal to securing financial stability and peace of mind in retirement. By understanding your options, assessing your needs, and seeking professional advice, you can make an informed decision to enjoy a financially comfortable retirement.
Have an amazing day.
Sue
