The annuity conundrum

Feel free to reach out to PSG Wealth Manager  Morné Oosthuizen directly.

Let us first examine the life annuity. This product pays a guaranteed income for the rest of your life, offering a number of options:

• You may add a guarantee period of 5, 10 or even 15 years. If you die before the end of the guarantee period, the company pays the income to your beneficiary until the agreed period expires. However, if you outlive the guarantee period, the company pays the income until your death. The longer the guarantee period you choose, the smaller the monthly income you will receive.
• You may decide on a fixed income or opt for an annual increase in income – at CPI or a fixed percentage of, say, 5%.
• You have the option to make the income payable until the death of the surviving spouse. This will enable your spouse to continue receiving the income. Here you may also choose to have only a percentage of the income paid out after the death of the first-dying spouse – e.g. 75%.

The most important benefit of this type of annuity is that you do not carry the investment risk of insufficient capital to cover the income. The fixed benefit you bought for life is now the life company’s responsibility. There might be a minor risk of the life company not being able to fulfil its obligation in the future, but we consider it to be a relatively small risk.

The biggest drawback of a life annuity is that the capital is not transferred to other beneficiaries on your death. In addition, once you have chosen this option the annuity cannot be changed going forward.

The second option is to invest your retirement savings in a living annuity. With this option you transfer your funds to an investment company, which will invest the capital on your behalf. You still carry the investment risk while you and your adviser must decide how the funds should be invested. This product also offers assorted options:

• You select the underlying investments and asset allocation. In other words, you may decide on an aggressive investment in offshore shares, for example, or a very conservative investment in the money market, or a combination of shares and money market instruments.
• In terms of legislation, you must select an income of between 2.5% and 17.5% per annum. If you expect an annual growth rate of 10% but withdraw 17.5% your capital value will decrease. At a drawdown rate of 2.5% your capital value will increase. So, if you draw too much income your capital will not be sufficient. However, if you choose a low enough income your capital may be sustainable and even increase in value.
• Furthermore, you have the option of annual, half-yearly, quarterly, or monthly income payments. You may exercise this option only once a year.

The biggest plus of the living annuity is that you may nominate a beneficiary/beneficiaries to receive your annuity on your death. Then they can continue with the annuity on the same basis, in turn nominating beneficiaries. This enables you to transfer your wealth to the next generation, which is not possible with the life annuity. A living annuity also provides more income flexibility, allowing you to adjust the income every year.

Another benefit is that your investment growth within the living annuity is tax free. The only tax payable will be on the income you receive.

The fact that you have to manage your own living annuity implies higher risk. If not managed properly throughout, there is a risk of your capital not being sustainable. However, conversely – higher than expected returns may boost your investment capital creating additional wealth.

The last significant difference is that you may choose to transfer from a living annuity to a life annuity at a later stage, but not vice versa. Only a portion of your capital can be transferred.

When it comes to choosing between the two options to invest your retirement savings, it is important to look beyond the income you will receive. The life annuity will always look better in this case, but remember – the reason for this is that all your capital goes to the life company. Therefore, it is essential to find the balance between your income and capital needs.

Although it is evident that both types of annuities have particular advantages and disadvantages, the final choice will be determined by every individual’s personal circumstances.