Does a living annuity terminate on death or after a fixed period?

Thank you for your questions.

First and foremost, we will discuss the structure of the two most common annuities, fixed and living annuities. The Long-Term Insurance Act makes provision for these products. The sole purpose of these two products is to provide financial cushion and lifestyle maintenance post-retirement, but this is largely dependent on pre-retirement savings. As a result, the greater the retirement savings made during your working days, the greater the monthly, quarterly, or yearly income received by an annuitant. In contrast, the lower the retirement savings, the lower the income received per nominated period.

We’ll go over these two types of annuities briefly before focusing on living annuities, which are the focus of this response to the questions above.

A fixed annuity, also known as a guaranteed annuity, entails transferring your retirement funds to an insurance company, which guarantees you taxable income for the rest of your life based on the initial investment. As a result, the annuitant is effectively protected against both longevity risk (the risk of living longer than expected) and investment or market risk (using up all your money due to poor returns). Another risk associated with this product is that the income payable may fail to keep pace with inflation.

However, the major setback with this product is that your money dies with you and is not passed on to your beneficiaries; you therefore do not nominate any beneficiaries. As such, if you die sooner than expected, your savings are forfeited.

A prospective annuitant has several fixed annuity or guaranteed annuity options, including but not limited to back-to-back annuities as well as joint and survivor annuities.

A joint and survivor annuity is a type of insurance tailor-made for retired couples who want guaranteed monthly income for as long as one spouse lives. Among other advantages, the annuity provides an income if one or both annuitants live longer than expected, resulting in additional income for lifestyle maintenance. Income payments to the surviving spouse could be made at 100%, 75%, or 50%. Income payments are slightly lower, but they last longer because they are anchored on life expectancy. Finally, provisions can be included to make payments to a beneficiary or beneficiaries if both annuitants die before the payments exceed the principal amount invested.

Back-to-back annuities provide a fixed, guaranteed income for life, backed by an insurance policy that allows you to pass on the capital to beneficiaries at the end of your life. Back-to-back annuities have the most visible benefit of lowering your annual taxable income because a portion of each contribution is considered a return on capital, saving the annuitant from the Old Age Security pension recovery tax. As a result, a large initial investment is always recommended in order to fully benefit from this annuity.

While a living annuity, which is the most common of the two, allows the annuitant to invest two-thirds of retirement funds into nominated diversified unit trusts which are not subjected to the dictates of Regulation 28 of the Pension Funds Act, which places confinements to offshore exposure. Please bear in mind that the offshore exposure is funnelled through rand-denominated offshore feeder funds instead of investing directly into offshore funds. As such, you can elect to invest 100% of your living annuity assets offshore, which however depends on your objectives, risk tolerance levels and ultimately your overall goals.

An annuitant is allowed an income level of 2.5% to 17.5% of the invested capital per year, which can be paid monthly, quarterly, semi-annually, or annually depending on the annuitant’s individual needs. This income drawdown or frequency can be adjusted in accordance with the anniversary date of the living annuity.

Now that we have touched on the structure of these two annuities, we are going to explain the tax implications with reference to the living annuities. If your annuity income exceeds the tax threshold, you will be subject to income tax based on the South African Revenue Service tax table.

What makes a living annuity more appealing is that it does not form part of your estate, allowing your designated beneficiaries to access your funds almost immediately.

As a result, your beneficiaries have the option of withdrawing the residual value in full, as an annuity, or as a combination of cash lump sum and annuity. Your beneficiaries, on the other hand, will be taxed using the current retirement tax tables. In this regard, your designated beneficiaries can change the drawdown rates.

Furthermore, a living annuity has no tenure as its existence depends on the initial capital invested and your life expectancy. However, if the market value of your life annuity is less than R125 000, you are permitted to withdraw the entire amount, effectively ending the annuity’s existence.

When you reach the age of 55, you are entitled to a third withdrawal from retirement funds, with the first R500 000 tax-free, provided you have never made any pre-withdrawals. If the pre-withdrawals were made, the dynamics change because the R500 000 is a cumulative lifetime total. The remaining two-thirds would then be used to purchase a mandatory annuity by the ‘bequeather’, who is solely responsible for naming the beneficiary or beneficiaries.

In short, the ‘bequeather’, not the beneficiary or beneficiaries, is entitled to a third withdrawal.

We hope we have adequately addressed the questions raised above; however, for a more detailed individual-specific response, we urge you to contact your financial planner or Global & Local The Investment Experts.