THE FINANCIAL WELLNESS COACH
The choice between a living annuity and a guaranteed life annuity
A guaranteed life annuity generally gives you a higher monthly income than you could sustainably get from the other type of pension — a living annuity.
Question: I am a 70-year-old pensioner and derive my income from a living annuity (from which I draw 2.5% each year) as well as drawdowns from my investment portfolio. I am thinking about converting my living annuity into a guaranteed life annuity, as I hear that the annuity rates are really good. Would you recommend this?
Answer: A guaranteed life annuity is an investment where you buy a series of payments for the rest of your life. This is a great product if you need income security when you retire. The risk of your capital (and income) decreasing if the markets fall has been passed on to the insurance company from which you bought the product.
A guaranteed life annuity generally gives you a higher monthly income than you could sustainably get from the other type of pension — a living annuity. One of the reasons for this is that with a living annuity, you need to budget on living to 100, while with a guaranteed life annuity, the insurance company that you bought the product from only needs to budget on you living to your life expectancy age.
So, to summarise, the main reasons for taking out a guaranteed life annuity are:
- You will get a higher monthly income for the rest of your life than you would get from a living annuity;
- The investment risk has been passed on to the company from which you bought the annuity, so you do not have to worry about the stock market falling; and
- Your pension will be paid for the rest of your life, even if you live beyond 100.
If I look at your situation, as you are only drawing 2.5% from your living annuity, you do not need a product that maximises your income. In fact, from a tax perspective, it makes a lot more sense to derive the bulk of your income from your investments, as you will only be paying capital gains tax on that income.
In addition, the assets that you are holding in your living annuity do not form part of your estate and will not attract estate duty when you die. I would therefore not recommend that you convert your living annuity into a guaranteed life one.
How to get the best of both worlds
An advantage of a living annuity is that you have a lot of freedom when it comes to choosing the type of investment in which you invest your capital. You can, for example, hold a portfolio of shares or bonds in this annuity.
One of the reasons life annuity rates are currently so attractive is that you can get 20-year bonds that offer a yield to maturity of more than 12%. If you invest your retirement capital in one of these bonds, you will effectively be locking in this return for the next 20 years.
This will give you a level of income security that is similar to what you are getting from a life annuity but with the advantage of you having a living annuity structure.
As you are only drawing 2.5% from the living annuity, the capital value of the investment will grow significantly. Remember that this will be outside of your estate, so no estate duty will be payable on the now much larger retirement fund.
As you can see, with a bit of planning you can get the best of both worlds by using a bond portfolio to provide income security for your living annuity. DM
Kenny Meiring is an independent financial adviser. Contact him on 082 856 0348 or at financialwellnesscoach.co.za. Send your questions to [email protected].
This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R29.
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How would one direct that all or a portion of a living annuity invests in 12% yield bonds? The options I looked at allowed selection from certain underlying funds.
For me the primary benefits in living annuity (LA) are:
1. Excluded from your estate for all purposes.
2. Can nominate beneficiaries, so in a way a DIY trust without the hassle.
3. Excluded from your CGT if you tax emigrate.
4. If, before retiring from an RA and transferring capital to LA you make enormous RA contributions, those disallowed deductions carry forward as deduction from the LA taxable income and you can use that massive RA contribution as a way to move funds into a vehicle that is outside your dutiable estate with zero donations tax issues. You can’t fund an LA other than from another retirement vehicle.
5. If you still earn other income, you can draw the minimum 2.5% and some institutions do offer clients LA with 0% fees meaning the LA pot can grow very nicely especially if consider that all growth of the funds in the LA are tax free in regard capital gains and income : only your drawings are taxed, as normal income.