On retirement the transition is obviously made from contributing/saving towards your retirement to drawing from your retirement funds. This is process is enabled by purchasing a annuity.
There are two categories of annuities
- A guaranteed life annuity and
- A living annuity
Guaranteed life annuity
A guaranteed life annuity will pay a fixed income with annual increases for the period of your life. These annuities typically pay a lower amount owing to the lifetime guarantee. As you purchase this annuity from a single financial institution all of your risk is concentrated with this company and you are entrusting them with you pension savings for what could be the next 20 – 30 years or more.
Another issue with a guaranteed life annuity is that typically all, or most, of your capital is forfeited when you pass away. Should this be within the first few years of your retirement it would have made this a very expensive option!
While a living annuity gives much more flexibility, including the amount that you withdraw every year this option does come with a bit more risk.
The flexibility relates the ability to change you mind in the future with regard in what you are invested in and, depending on your circumstances, the ability to vary the capital/income you draw. These products allow you to nominate a beneficiary so that when you pass away your assets/capital does not accrue to a financial institution but will be paid to either your estate or your nominated benficiary/ies.
The risks relate to having your portfolio exposed to the risks associated with the investment market as well as your longevity i.e. the risk that you live too long! The global life expectancy has increased by 22 years in the past 62 years. If you retire at 60, living to 75 or 95 have fundamentally different funding requirements which a living annuity is not able to manage.
The decision as to which annuity to purchase is critical and the consequences of making an incorrect decision can be significant.
Anyone retiring from a registered retirement fund i.e. retirement benefits that are regulated by the Pensions Fund Act, be that a pension, provident, retirement annuity or a preservation fund, can purchase an living/life annuity. Living/life annuities therefore cannot be purchased with funds classified as a discretionary investment.
Setting up an annuity is relatively easy, but there are a number of factors that need to be considered.
Firstly, you will need to decide whether to commute up to one-third of your retirement fund as cash lump sum or to invest the full amount of your fund in an annuity (keeping in mind the tax implications of the tax on lump sums).
Most investment platforms stipulate a minimum contribution limit of between R50 000 and R100 000 in respect of an initial lump sum. You are also able to make additional contributions provided that the benefit is from another approved retirement fund.
There is no age limit for purchasing an annuity; however, generally speaking, you will not be permitted to retire from your retirement fund before age 55 which means you have the option of purchasing an annuity any time from age 55 onwards.
If you are invested in a living annuity, the policy falls under the Long-Term Insurance Act and therefore your investment is not subject to Regulation 28 of the Pension Funds Act which limits offshore exposure. As such, you can elect to invest 100% of your living annuity assets offshore, depending on your goals and objectives.
The legislation permits you to draw a pension income from your living annuity between 2.5% per year and 17.5% per year of the value of the residual capital. You can choose to draw down on a monthly, quarterly, bi-annual or annual basis, depending on your personal circumstances, and you have the option to adjust your drawdown rates every year on the annuity’s anniversary date.
Once you are invested in a living annuity, all growth including interest income, dividend income and capital gains are tax-free. Any income withdrawn from your living annuity which exceeds the tax threshold will be taxed according to the normal tax tables.
Generally speaking, you can transfer your living annuity to another investment platform and to a different investment strategy with no tax implications and at no additional cost.
Legislation permits you to switch your living annuity to a life annuity, but not vice versa. This is because a life annuity is an insurance policy which is purchased with the capital in your living annuity.
Once you have retired from a retirement fund and invested in a living annuity, the pension interest is zero and your spouse will have no claim against the money in your living annuity. A distinction must be made between:
- the capital invested in the living annuities and
- the right to receive a regular annuity payment from the insurer based on the capital value of the underlying investment.
The capital portion of the annuity reflects on the insurer’s balance sheet and therefore belongs to the insurer. As such, the annuitant only has a contractual right to receive a regular payment from the insurer and the capital value cannot be taken into account when determining the accrual. With regard to the annuitant’s right to receive regular payments from the insurer, the right to these payments is an asset in the annuitant’s estate and can therefore be taken into account when determining the accrual.
The capital in your living annuity may not be attached by means of a court order should you be declared insolvent. However, any income drawn from your living annuity does not enjoy the same protection and may be attached by your creditors.
Reach out to Ubuntu Capital and a professional financial planner will get hold of you to explain everything and discuss any of your requirements.
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