Options at Retirement - How do I receive an income?

The intention of this article is to provide retirees with options at retirement. I have focused on retirees who hold Retirement Annuities (RA’s), Preservation Funds, Pension Funds & Provident Funds. I have avoided the Government Employees Pension Fund (GEPF) and other state-owned funds in this article. Currently the normal retirement age for the GEPF is age 65, and they follow different rules.

Scenario: Retirement Annuities & Preservation Funds
You decide to retire and own one or more Retirement Annuities or Preservation Funds and are over the age of 55 in terms of the product rules.

Scenario: Provident & Pension Funds
You decide to retire after working for an employer for several years and have reached retirement age in terms of your contract of employment and in terms of the fund rules.

What are my options at retirement?
You have the option of taking a maximum 1/3rd of your retirement money as a lumpsum at retirement (i.e., you can take this as a cash pay-out). The exact amount of lumpsum that one can access depends on the rules of your retirement fund and is calculated on your total fund interest. But be careful, your lumpsum’s from all retirement funds are subject to aggregation and taxed as follows:

Scenario: We assume that no lumpsum is taken at retirement, the full benefit is used to purchase:
1. A Life Annuity;
2. A Living Annuity or
3. A combination of a Life Annuity and a Living Annuity:

1. A Life Annuity
A retiree has the option of moving his retirement savings into a Life Annuity at retirement. In this instance an adviser will typically do a suitability study to determine the retirees’ exact financial needs. A Life Annuity often provides more predictability to investors as the monthly income paid to the
investor is linked to their life expectancy. Although there are exceptions, most often the life insurance company stops all income payments at death as the income was linked to your life. The general premise is that the longer you live the more benefit you receive.

A Life Annuity takes many forms, below are a few scenarios that insurers (such as Old Mutual, Sanlam, Momentum, Liberty Life etc) cater for at retirement:

Single Life Annuity:
Here the annuity paid to the retiree is based on only his/her life. There is only one life assured. The insurer will take many factors into account and calculate a monthly income that will be paid to the annuitant for the rest of his/her life. Income can be paid monthly, quarterly, semi-annually or annually. When comparing Life Annuities, the Single Life Annuity usually offers the highest income pay-out to a retiree.

Joint Life Annuity:
In this instance an insurer undertakes to pay the life assured for the duration of their life and for the duration of their spouses’ life. It is therefore reasonable to assume that the income paid to the life assured will reduce because the chance of survival increases when two lives are insured.

Inflation Linked Life Annuity:
If you are worried about the effect of inflation on your income, one option is to take out an Inflation Linked Life Annuity, here the annuity increases each year by CPI or other predetermined amount (e.g. 5% p.a.). The income paid to the life assured starts off lower than a plain single life annuity, but increases each year.

Life Annuity with Capital Protection:
Contrary to popular belief, there are products that offer lump sums to beneficiaries at the annuitant’s death. The retiree can select a specified amount of life cover at retirement date. Two policies are purchased from your retirement capital, one policy provides you with a guaranteed annuity income, the other policy funds the premiums of your life policy which pays out on your death.

Guarantee Period:
Insurers also offer retirees a guarantee period (in most cases the first 10 years) which then obligates the insurer to pay the life assured’s beneficiaries an income for the remaining guarantee period. Can you imagine investing R5.0 mil into a life annuity and then getting knocked down by a bus? A 10-year guarantee period offers some protection to beneficiaries.

* Be aware that this list is not all-inclusive and there are many options that can be tailor made to fit your retirement needs.

2. A Living Annuity:
A Living Annuity has become a very popular choice for retirees as it remains more flexible than Life Annuities.

Purchasing a Living Annuity implies that there is no underwriting on your life, this effectively means that at death, your beneficiaries will receive the remaining capital – a major positive.

Once you have elected to purchase a Living Annuity, you are required to select an income which ranges between 2.5% and 17.5% p.a. Your income can be paid over to you at any frequency of your choosing, usually monthly. Your income can only be adjusted once a year on the anniversary date of your Living Annuity.

The capital value of your Living Annuity can be invested (with the help of your advisor) into a portfolio of funds or shares or both, but the investment options are usually linked to the platform which you select to house your Living Annuity. Examples of platform providers include Allan Gray, Glacier and Ninety One to mention a few.

All money invested into a Living Annuity is tax-free, that is, you do not pay Capital Gains Tax (CGT), no dividend tax and no tax on interest earned. The full capital value held within a Living Annuity passes on to your beneficiaries’ tax free if they choose to move the full benefit into a Living Annuity. You are however taxed at your marginal tax rate on the income you withdraw out of a Living Annuity (ignoring disallowed contributions).

A Living Annuity is not subject to Regulation 28, which means you and your adviser can invest into any asset class of your choosing, both locally and offshore. Popular asset classes are shares, bonds, property and cash.

The flexibility of a Living Annuity remains key. One can always move a Living Annuity into a Life Annuity should circumstances change, but the opposite is not allowed, you cannot move out of a Life Annuity. A Living Annuity’s flexibility can also be its downfall as some clients may choose to withdraw an unsustainable amount of income. The risk is therefore that your capital and income reduces over time. You also run the risk of making poor investment choices which reduces capital.

3. Hybrid Option:
In recent years investors have been able to convert a portion of their Living Annuity into a “With-Profit Life Annuity” thereby providing the retiree with a guaranteed income from that portion of retirement money.

The portion of capital invested into a Life Annuity will produce an income that will never reduce, and can increase depending on market returns. But remember, there is no going back with Life Annuities.

In conclusion
Choosing an appropriate vehicle to house your retirement money is crucial. You need to consider your capital, your income, the tax implications and your investment risk. There is no one size fits all, but your financial adviser should at very least talk you through your options.

Please feel free to make an appointment with our office to discuss your retirement plans and options and we will help guide you in the right direction.