When working people reach retirement age, they should have saved enough money to live off their savings. But it is also important that they understand how that money will generate an income. There are different types of annuity products to choose from and with some, once you’ve made a choice, it cannot be undone.
It is necessary to think about your choice properly before you decide, Kamal Patel, senior financial adviser at Old Mutual Personal Finance, says. “People entering retirement must thoroughly understand their annuity options and the best way to do this is with the help of a financial adviser.
“What you choose will depend on a number of factors and the most important are how much you saved, how long you expect to live in retirement, how comfortable you are with investment risk and whether you would like to leave capital for your loved ones.”
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Different rules for different products
Patel points out that certain rules apply regarding savings in a retirement fund, such as a pension fund, provident fund, preservation fund or retirement annuity.
“If your fund value is more than R247 500, you are allowed to withdraw only one-third as cash, of which the first R550 000 is tax-free. You must use the remaining two-thirds to buy an annuity, which will provide a monthly income subject to tax for you.”
Patel says there are two basic types of annuities, although providers offer variations on each. “You do not have to invest all your savings into one or the other and many people choose a combination of both.”
The two options are a life or guaranteed annuity and a living annuity.
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Life or guaranteed annuity’s rules
This is a pension bought with your savings from a life insurance company, where your monthly income is determined at inception and paid for life, while the risk lies with the insurer. You can choose a level annuity or, at a lower initial income, opt for an annual escalation of, say, 5% to keep pace with inflation, Patel says.
You can choose between a single-life annuity, where the income is paid to you for the duration of your life, or a joint and survivorship annuity, where the income continues to a second person (usually your spouse) after your death, but choosing this option to secure an income for your spouse, generally reduces your initial income.
However, Patel says, the annuity may also include a guarantee period, which ensures that the income continues to be paid to a nominated beneficiary if you pass away within that period.
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How a guaranteed or with-profit annuity works
For example, he says, if you select a 10-year guarantee period and live beyond the 10 years, the income will continue to be paid to you for as long as you live, but no further payments will be made to your beneficiaries after your death.
However, if you pass away in year five, the income will continue to be paid to your nominated beneficiary for the remaining five years, ending at the conclusion of the 10-year guarantee period.
Another life or guaranteed annuity is a “with-profit” annuity, where your savings are invested in market-linked portfolios. The insurer will guarantee a minimum income, but any increases will depend on investment performance.
“It is important to note that a life annuity is, literally, for life. You cannot opt out or transfer your savings to a different product once you are in it. You must also understand that, outside the guarantee period, there is typically nothing left over after your or your surviving spouse’s death”.
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Living annuity requires you to ensure you have enough when you retire
This is an investment portfolio where your income is derived from the returns generated by the underlying assets. You can choose from a range of funds on the provider’s platform, which are subject to fluctuations in the financial markets.
Once a year, on the anniversary of inception, you decide what percentage of your capital to withdraw as income, between 2.5% and 17.5%. However, the higher the percentage you withdraw, the faster your capital will be depleted.
“In a living annuity, you take on the responsibility of ensuring that your pension lasts for life. It is therefore essential that you manage it with the ongoing guidance of a trusted financial adviser,” Patel says.
“An advantage of a living annuity is that you can transfer to another living annuity or to a life annuity at any time. In addition, any remaining capital still invested in the living annuity at the time of your death will be distributed to your beneficiaries, subject to certain conditions,” Patel says.
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As you approach retirement, take the time to review your income options carefully. Patel says the right annuity choice depends on your unique circumstances, including your income needs, health, lifestyle goals and risk tolerance.
A life annuity can offer peace of mind and certainty through a guaranteed income, while living annuities offer flexibility and growth potential but also require active management.
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