When you retire from a pension, provident, preservation, or retirement annuity fund, South African legislation requires that at least two-thirds of your accumulated savings be used to purchase an annuity, which is essentially your income stream for the remainder of your life. For most people, this is one of the most important financial decisions they will ever make. It is often complex, sometimes overwhelming, and, in many respects, irreversible. That is why it is essential to fully understand the features, benefits, and risks of a living annuity before committing to one.
A living annuity is not an insurance policy in the traditional sense. Rather, it is an investment product governed by the Long-Term Insurance Act, where your retirement capital is invested in assets such as unit trusts, shares, bonds, or cash, all held in your name. Unlike a life annuity, you carry the investment risk, meaning that poor market performance can directly reduce your capital.
You also carry the longevity risk, which is the risk of outliving your savings. While there is no maximum age for purchasing a living annuity, you can only access the structure once you have formally retired, which for most funds is from age 55. Once the annuity is in place, you are obliged to draw a regular income—whether monthly, quarterly, biannually, or annually—and the responsibility for ensuring your capital lasts lies with you, meaning that there are no guarantees on your capital value. Simply put, the performance of your investment, together with the fees you pay and the rate at which you draw an income, will determine how long your savings will last.
One of the primary attractions of a living annuity is the investment flexibility it offers. Because it is not governed by the Pension Funds Act, the Regulation 28 asset restrictions fall away, and you can design a portfolio without caps on offshore exposure or equity holdings. This investment freedom allows you to structure the investment according to your risk profile, income requirements, and investment horizon. You might choose to invest entirely in South African growth assets, blend local bonds and equities for stability, or allocate your portfolio entirely offshore through rand-denominated feeder funds – although keep in mind that you cannot invest directly in foreign-domiciled funds within a living annuity. While this freedom creates opportunities for inflation-beating returns, it also carries the responsibility to ensure that the portfolio remains aligned with your needs and tolerances. Too much exposure to low-yielding assets may cause your investment to lag behind inflation, while excessive risk could result in short-term capital losses that threaten the sustainability of your income.
Your withdrawal rate is one of the most critical variables in determining whether your living annuity will provide sustainable income throughout retirement, bearing in mind that legislation requires that you withdraw between 2.5% and 17.5% of your capital each year, with the option to adjust the percentage annually on the policy’s anniversary. While the upper drawdown limit may look appealing, keep in mind that drawing too much too soon is the most common reason retirees run out of money. Industry research suggests that starting with a drawdown rate of around 4% to 5% in the early years, and keeping it below 8% later in retirement, greatly improves the likelihood of maintaining income for life.
On this note, remember that you cannot withdraw lump sums from a living annuity outside of your chosen annual income. The only exception is if your balance falls below R125 000, in which case you may cash it in. This makes it vital to maintain a separate emergency fund outside your annuity to cover unforeseen expenses without jeopardising your long-term plan.
The tax treatment of a living annuity is another important consideration. Inside the annuity, there is no tax on interest, dividends, or capital gains, allowing the investment to grow tax-free, although once you start drawing an income, it is taxed as retirement income at your marginal tax rate. This is because SARS applies PAYE to annuity income in the same way as it would to a salary. If your drawdown produces more income than you need, note that the surplus can be invested into a discretionary portfolio, or even back into a retirement annuity within your annual contribution limits to claim a tax deduction and defer taxes.
Living annuities also have unique estate planning advantages. Unlike retirement funds regulated by Section 37C of the Pension Funds Act, you are free to nominate any beneficiaries you wish, knowing that the proceeds will be paid directly to them. In such circumstances, the proceeds do not form part of your deceased estate, thereby avoiding estate duty and executor’s fees. Your beneficiaries have the option to take a taxable lump sum or to continue the annuity in their own name, with the income taxed at their marginal rate. Further, while the capital in your living annuity is protected from creditors, note that the income you draw is not subject to the same protection. It is therefore important to review your beneficiary nominations regularly, particularly after major life events such as marriage, divorce, or the birth of a child, to ensure your estate plan remains aligned with your wishes.
Should you emigrate after starting a living annuity, keep in mind that the investment must remain in South Africa, where the income will be paid into a South African bank account from which you can transfer the funds into your chosen foreign currency. While it is not possible to transfer your living annuity abroad, you retain full flexibility in terms of the underlying investments, which can be adjusted as your needs evolve. You may also transfer the annuity between local investment platforms without incurring tax or penalties. If at a later stage you decide that you prefer the certainty of a guaranteed income, you can convert your living annuity into a life annuity – although note that it can then not be converted back to a living annuity.
Costs are another area that deserves careful attention, as even a seemingly small difference in annual fees can have a dramatic impact over a retirement spanning 20 or more years. Fees typically include administration charges, fund management costs, advisor fees, and transaction expenses. Before committing, request the effective annual cost (EAC) calculation, which expresses all ongoing fees as a single percentage, making it easier to compare products and platforms.
Having addressed the longevity and inflationary risks inherent in a living annuity structure, it’s important not to ignore the behavioural risks. Behavioural risks can arise when investors make emotional decisions, such as selling growth assets after a market drop, which can lock in losses and undermine recovery potential. A sound financial plan should address all three of these risks through a combination of appropriate asset allocation, disciplined withdrawal strategies, cost control, and regular reviews.
Choosing a living annuity is a once-in-a-lifetime decision for most people. When done well, it can provide flexibility, growth potential, and estate planning benefits that support both your lifestyle and your legacy. With this in mind, we recommend making this choice deliberately, using accurate cash flow projections, a clear understanding of your risk tolerance, and an honest assessment of your income needs. Importantly, it is not a decision to be rushed or taken in isolation. A carefully considered living annuity, managed with discipline and reviewed regularly, can give you both the income and the peace of mind you need to enjoy your retirement years with confidence.
Have a great day.
Sue
