THE LIVING ANNUITY CONUNDRUM
Living annuities are the most popular choice of annuities in South Africa, but they are also typically a risky choice, because you have to draw an income from your capital, which is invested in the financial markets and therefore subject to fluctuations in value in line with the movements of those markets.
The Income Tax Act obliges retirees with living annuities to draw an income of between 2.5 percent and 17.5 percent of the capital in a living annuity each year.
Research by local and international companies has determined that a safe income level to draw is around four percent. The Association of Savings & Investment SA (Asisa) has determined safe withdrawal levels for different age groups.
The average withdrawal rate, is, however, typically higher than recommended levels, at around 6.4 percent, according to Asisa.
At the beginning of the year, you may decide on a level at which to draw an income from your annuity – for example, four percent. But if the markets fall sharply during the year, the rand amount you are withdrawing may suddenly increase to, for example, six percent of your capital.
If your capital does not recover quickly and you continue to draw down the same rand amount, the percentage of your capital you are withdrawing as an income will increase each year until you hit the maximum withdrawal level of 17.5 percent a year.
When that happens, you will be forced to withdraw an income that diminishes in rand terms each year.
The alternative to a living annuity is a guaranteed annuity. This guarantees an income in retirement for the rest of your life, regardless of how long you live. Many people are reluctant to take out guaranteed annuities because when you die the remaining capital reverts to the life assurance company.
There are ways to mitigate the risk of your heirs losing the capital, by taking out a guarantee on the income for the first 10 years, for example.
Alternatively, some financial institutions recommend taking out life cover to provide for your heirs.