Designing Your Future: the choice between Living Annuities and Retirement Annuities
When we plan for retirement, we’re often doing it when we’re young, say 30 or 40 years before the event. It’s difficult to foresee the future at this age, but the choices made at this point can affect the final outcome and the way we will live our lives once our working years have come to an end.
Ultimately, there’s no wrong or right in the initial choice, rather an emphasis on individual perspective, lifestyle, risk aversion and prevailing conditions at the time of decision. There is considerable difference between a traditional life annuity or a living annuity – and it’s good to gauge the distinction between the two and the long-term effects.
The more traditional route – also known as a life annuity or guaranteed annuity or fixed annuity – is often chosen for the security of a lifelong pension. With a life annuity you give a lump sum to a life assurer, and upon retirement, will receive a set amount (fixed interest rate) in monthly payments for the rest of your life.
- This monthly payment is determined by the amount you invest, your life-expectancy, and the prevailing interest rates on the day that you purchase the life annuity.
- The life assurance company determines how long you might live – and bases the payments on this. The shorter your life expectancy, the higher your monthly payment will be. This is why women so often receive a lower monthly payment because they are expected to live longer than men.
- The interest rate when you purchase the policy is important to note, because that rate is locked in for life. So shopping for a retirement annuity when the rates are high is a good idea – the higher the prevailing interest rates, the higher your monthly pension is likely to be.
- The advantage of the life annuity is that you will continue to receive your payments until you die. If you outlive your projected life expectancy, the insurance company will suffer a loss because they will have to continue paying you. However, if you die before the sum invested is finished, the insurer claims the rest. It does not go to a beneficiary. So your heirs effectively lose out if you choose the security of a retirement annuity.
- For many who are risk adverse, this choice is a safer choice. It effectively insures you against the risk of longevity and/or using up your general savings due to mismanagement of funds or poor stock market returns.
- You can also choose a guaranteed annuity that will continue to pay your spouse for a number of years – but this means you will receive a smaller payment each month. An annuity that provides a spousal benefit will pay out less than an annuity that does not.
- Always shop for the best available rate, with the following in mind: the younger you are when you take out your pension, the longer you are likely to live, and hence the lower your monthly payment.
The more modern alternative to the life annuity is the living annuity, also known as a flexible annuity. A living annuity is simply an investment account from which you withdraw an income – but instead of a fixed interest rate paid on your lump sum at the time of purchase, you are able to choose the funds into which your contributions are invested. You therefore take responsibility for the performance of your investment yourself, but you do have potential of greater capital gains in the longer term.
- In this way, living annuities are riskier than fixed or life annuities, but you do have greater income flexibility. Secure increases in income depend entirely upon investment performance and the rate of your withdrawals. Risk lies in the fact there are no guarantees of any sort – your investment may not perform well or the market may decline dramatically. Essentially, the living annuity is an investment product, so you will still have to consult a financial advisor on how best to handle your investment choices.
- Every year you must draw a pension from your investment. This amount is limited to by SARS to a range between 2.5% and 17.5% of capital per year.
- When you die, the residue can be left to a spouse or children, depending on who survives, failing which it goes to your estate where it is not subject to Estate Duty.
- You can switch a living annuity into a guaranteed annuity (although you cannot do the reverse). You can take out both types of annuities concurrently or purchase a composite annuity (both living and guaranteed) under a single life assurance policy.
- It’s important to remember that you should not consume all your capital too quickly in case you live longer than expected. While you can choose your own pension amount each year, choosing a high pension means that your money will run out before you die.
Making your decision
There’s a lot to consider before you make your choice. Age, health, life expectancy, the current state of your savings, what you would like your income to be, family circumstances, interest rates, investment costs and prospective outlook.
Age: if you retire young, a low-cost living annuity may be the best choice as your life expectancy, being much longer, will reflect negatively on a guaranteed annuity. But if in your sixties or seventies, the guaranteed annuity is a good option because your life expectancy has fallen and you are likely to receive a better monthly pay out.
Health: poor health will see you needing your money sooner rather than later. In that case, a living annuity with a flexible draw-down rate may suit you more. This also ensures that your capital does not die with you.
Costs: an important consideration with any investment. A living annuity can potentially be expensive. Most living annuities charge initial fees, annual fees, transaction charges and investment management fees (on top of any advice and platform fees you may pay). These charges may run as high as 2.5% pa of your capital. Therefore it is always wise to ensure that you consult with a reputable financial organisation who will outlay all charges, assist you to find the most sensible and beneficial balance, and be upfront with their advice fees.
A financial partner guaranteed for life
Foster Private Clients, backed by the proud 28-year history of the Foster Group, believes in working for only the best results in all areas, from investments through to retirement planning, and including insurance matters. Creating a personal partnership with each client – and mindful of every individual’s plans, dreams and goals – we are there to guide and advise you on each milestone of your financial journey, not only during your working years but well into retirement.
For us it’s about more than just generating income and retaining capital in investments, it’s about the quality of your life each step of the way and your peace of mind. That’s why we focus on building sound relationships based on professionalism, experience, and friendship.
Find out more about us at: www.fosterprivateclients.co.za
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