Life and living annuities in the context of your estate plan

Estate planning

While both life and living annuities are designed to provide retirees with an income throughout retirement, their respective functions in the context of estate planning are vastly different – and it’s important for policyholders to understand these differences to ensure that one’s estate planning goals can be achieved. In this article, we unpack how each type of annuity is dealt with upon the death of the policyholder.

What are the key differences between living and life annuities?

The first point of departure is to understand the fundamental differences between a life annuity and a living annuity, which can be summarised as follows:

Living Annuities: Living annuities are personal investments held in the name of the annuitant. Governed by the Long-Term Insurance Act, these vehicles are actually investments linked to unit trusts, cash investments and share portfolios held in the investor’s name. Living annuity investors have full investment flexibility in that they can select their underlying funds and asset allocation, meaning that the value of the fund will fluctuate according to market movements. As a living annuity is not an insurance policy, it is important to note that the annuitant effectively takes on all longevity and investment risk. In terms of accessibility, there is no upper age limit for purchasing a living annuity, although the earliest a person can retire from a retirement fund is age 55 – which means that investors can only invest in a living annuity from this age onwards. Once the living annuity has been set up, the annuitant is required to draw an income of between 2.5% and 17.5% of the residual value of the fund per year, with the option to amend the draw-down rate annually. Being an investment, investors should remain aware that a living annuity offers no guarantee on capital, and annuitants need to undertake careful planning to ensure they don’t run out of capital. Once the total value of the living annuity falls below R125 000, the annuitant is permitted to disinvest the full value.

Estate planning considerations: As the funds held in a living annuity belong to the annuitant, the annuitant can nominate beneficiaries to receive the funds in the event of death. Where the living annuity is required to create liquidity in an estate, the annuitant can nominate their estate as the beneficiary.

Life Annuities: Unlike living annuities, life annuities are insurance policies purchased by the policyholder from an insurer where the policyholder effectively swaps a lump sum in exchange for a guaranteed income for the rest of their life. The insurer is responsible for providing the ongoing income and taking all investment and longevity risk, meaning that the policyholder has no interest in the lump sum. Being contractual, life annuities can be structured according to the needs and affordability of the policyholder, with options that include level income, inflation-linked income or fixed-escalation income. Such policies can also be structured to provide an income until the death of the last-dying spouse, known as joint survivor policies.

Estate planning considerations: Generally speaking, life annuities have little estate planning value as most policies cease to exist on the death of the policyholder or the death of the second-dying spouse.

What happens to your annuities in the event of your death?

Here we take a closer look at the significant estate planning differences between living and life annuities:

Living Annuities: Living annuities can play an important estate planning role if correctly structured. Where the annuitant nominates beneficiaries, any residual value remaining in the event of their death will be paid to the beneficiaries and, in doing so, will bypass the deceased estate and any estate taxes. As such, living annuity structures can be used effectively to reduce the overall tax liability in your deceased estate while also making financial provision for your loved ones who will have almost immediate access to the funds. In the event of your passing, your nominated beneficiaries have the option to take the full amount in cash (subject to your retirement tax tables) or to keep the funds in a living annuity structure from which they must then draw a regular income.

If no beneficiary is nominated, the residual value of the investment will form part of the deceased estate and be included for estate duty purposes, and the funds in your living annuity will be distributed as part of your estate. What is important to note is that, if you die without a valid will, these funds will be distributed amongst your intestate heirs in accordance with the law of intestate succession.

Life Annuities: As life annuities are long-term insurance policies, policyholders can elect to add life cover to the policy to provide for their loved ones or to create liquidity in the estate. However, in general, a life annuity dies with the policyholder and there is no lump sum benefit available for distribution to heirs or beneficiaries. As mentioned above, policyholders can structure a joint-life annuity that ensures the annuity income is paid until the death of the last spouse, or a guaranteed life annuity that guarantees the annuity income for a pre-determined period of time, for example, ten years. However, on the death of a life annuity, there is no lump sum benefit available for distribution.

As is evident from the above, both life and living annuities can be effective in providing one with a post-retirement income, but their respective roles in the context of your estate plan differ vastly. As such, before choosing an annuity, we strongly advise that you seek guidance from a qualified, independent financial advisor with experience in retirement planning.

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