WeeklySA_AdminCRITICAL CHOICE: Important to create split between basic living expenses and luxury or nice-to-have.
By Isaac Moledi
Annuity, what is it and who should have an annuity? What is the difference between an annuity and a living annuity? Annuities are financial products that retirees ‘buy’ with the money they have saved in their pension, provident or retirement annuity funds (RA) to give them a steady income over time.
Annuities are created and sold by financial institutions that invest your lump sum premium so you can be paid a monthly income during retirement, based on the type of annuity you have purchased or your specific income stipulations.
Financial advisors believe that retirement annuities in South Africa are attractive savings mechanisms because they offer substantial tax benefits. You can invest up to 27.5% of your annual taxable incomes (up to R350 000 annually) on a tax-deductible basis. The advantage is that even if you have a company pension or provident fund, you can still invest in an RA. For example, if a company plan contribution is only 15%, you can invest the balance of 12.5% in an RA without attracting tax.
Other befits include:
• No income tax or capital gain tax is charged on investment returns within an RA.
• Funds in an RA do not form part of an estate, so after a holder’s death, they are not liable for estate duty or executor fees.
• On retirement, investors can withdraw up to one-third of the value of the retirement annuity(s) of which the first R500 000 of the total withdrawal is tax-free. Experts say to get the best benefit possible from an RA, you should:
• Open an RA as soon as you can. The younger you are, the longer the RA will work for you, and the better the retirement benefit.
• Ideally, committing yourself to an RA payment should be undertaken when you start your first job.
• Premiums should be increased whenever you get an increase and at least annually so that the investment keeps pace with inflation.
Considerations when choosing an annuity.
There are many things to consider when finding an annuity that suits your needs. John Manyike, head of financial education at Old Mutual believes that as a person approaches retirement, there are some questions to ask yourself, or your fund members. These include:
• What sort of life expectancy might you have in retirement? It pays here to think about how long your parents and grandparents lived, how good your health is and about health factors that might affect your lifespan.
• How much starting pension will you get for a given amount of capital? (See the difference between life annuities and living annuities below)
• The underlying costs of the various products?
• Is the annuity provider reputable with a solid track record in annuities?
• What are your monthly living expenses? How are these split between basic living expenses and luxury or nice-to-have costs? How does the pension amount compare to your living expenses?
• What sort of increase in a monthly pension can you expect in future, and how does this match up to inflation?
• Will you continue to receive an income for the rest of your life or is there a risk of running out of money?
• Is your spouse (and any other financial dependants e.g., a child with a disability) covered by the product if you die?
• Is it more important to you to have control over the investment and income or to have a guaranteed income for life?
• Do you have other capital outside of the retirement fund that could be invested in complementary solutions for a more holistic solution?
• Would it be beneficial to consider a combination of one or more products rather than just one?
• What if your circumstances were to change? It is not a given that your health, lifestyle, marital and financial status will remain the same throughout retirement. If it changes, will the solution still be relevant?
Life annuities and Living annuities
Manyike describes life annuities as those that are essentially a guarantee to pay a certain monthly (pension) amount for the rest of your life. There are different types of life annuities that provide different levels of future increases in the monthly pension amount.
As a rule, the higher the annual increase you select, the lower the starting pension amount you will get. The options are:
• A Level annuity: where the monthly pension does not change and does not increase in line with inflation or investment returns.
• A Fixed escalation annuity: where pensions increase every year at a predetermined rate that is not linked to inflation or investment performance.
• An Inflation-linked annuity: where the pension increases annually in line with official inflation.
• With-profit annuity: Your monthly income will increase at an annual rate decided by the insurance company that provides the annuity and is based on various factors, including investment returns.
The life annuities can also have an option that provides a spouse with a pension if the holder dies.
Living annuities
A living annuity on the other hand enables you to decide on the level of income you would like to receive every year and can be between 2.5% and 17.5% of the total investment value. You can also choose where the annuity is invested. If the markets perform poorly, your total investment amount can decrease, and your income along with it. The pension will be paid for as long as there is money remaining in the investment; if the investment is depleted, your income will stop.
