What is the best retirement annuity for my pension?

An RA (retirement annuity) is a pre-retirement product. You should discuss your options with a financial advisor to determine what is the best retirement annuity for you. Here is some background info: You can take your full provident fund balance as a lump sum (net of tax) As a member of a pension fund, you may not take more than one-third of your proceeds as a cash lump sum. With the balance you must buy an annuity. 

Cash lumps confer certain tax advantages: no tax is charged on the first R500 000, the balance to R700 000 is taxed at 18% and the balance to R1 050 000 at 27%. The remainder of your lump sum is taxed at 36%. The cash lump sum will reduce the amount available to purchase an annuity, and you will accordingly receive a lower monthly income for the rest of your life. If you lack the discipline or financial acumen to deal prudently with your cash lump sum, you should consider taking less than one-third as cash. As a member of a pension fund, you must use at least two-thirds of your fund proceeds to purchase an annuity. The annuity will provide you with a regular income stream for the rest of your life. You are not permitted to buy a fixed-term annuity that only pays out for a specific number of years. Your annuity income is taxed according to the personal income tax tables prevailing at the time. 

You can choose between two types of annuities: a Guaranteed Annuity or a Living Annuity. 

1. Guaranteed Annuity 

The Guaranteed Annuity (GA) is an insurance product (policy). It provides you with a specified monthly pension for the rest of your life. You must purchase this annuity from a life assurance company, which effectively insures you against longevity risk (the risk that you live longer than expected) as well as investment risk (earning insufficient return on your capital to pay your pension). The full pension is paid until you die. The drawback is that your capital dies with you, and no money passes onto your heirs. That is your risk: you (or, rather, your heirs) forfeit your savings in the event that you die sooner than expected (unless a guarantee or life assurance is built into the contract). Annuity rates (the pension that you receive) are variable and can differ from one life assurance company to the next. As you may receive a different income for the same amount invested, you should shop around for the best available rate at the time. Life assurance companies consider a number of factors in determining your annuity rate:

• Your age: the younger you are, the longer you are likely to live, and hence the lower your monthly pay-out.
• Your gender: women have a higher life expectancy than men, on average, and therefore receive a lower pension.
• Interest rates: the higher the prevailing interest rates, the higher your monthly pension is likely to be
• Your choice of annuity: you have a number of product options, with different risk profiles. The more insurance you require, the lower your annuity will be.

Guaranteed Annuity products: Level or fixed annuity. You receive the same amount every month for the rest of your life. This means that your income does not insure you against inflation; the purchasing power of your annuity (and hence your standard of living) will thus gradually decline. 

Escalating or variable annuity. This annuity increases annually, either by a fixed amount, or in line with a pre-determined inflation index, such as the Consumer Price Index (CPI). An escalating or inflation-linked annuity will pay out less than a level annuity initially, but will maintain its purchasing power and thus gradually overtake the fixed annuity in value. 

Guaranteed and then for life annuity. This annuity will pay out less than the first two, as it insures you against the risk that you die soon after retiring and thus forfeit the bulk of your retirement savings to the life assurance company. This annuity (fixed or variable) is guaranteed for a set number of years (typically between 10 and 20); should you die within the guarantee period, your heirs will continue to receive your pension for the remainder of the guarantee period. You will continue to receive your pension if you survive the guarantee period, but then the payments will cease upon your death (i.e. your heirs no longer benefit). 

Capital-back guaranteed annuity. This combines an annuity (fixed or variable) with a life policy. Your annuity is reduced by a premium, which pays for a life assurance policy, to the benefit of your heirs. 

Joint and survivorship annuity. This annuity ensures that your spouse will have an annuity (fixed or variable) after your death. You select the income level the surviving spouse will receive (typically 75%). This is recommended for couples where only one spouse has accumulated retirement savings. This type of annuity pays out less than a single person annuity, as the longevity risk increases for the life assurance company. 

With-profit annuity. This is an escalating pension, guaranteed for life; however, the rate of increases is not guaranteed and depends on the net (after cost) investment performance of your initial investment. Increases are declared as bonuses; and once declared, become permanent (ie part of your guaranteed pension). Pension increases are subject to smoothing, ie the life assurance company holds back some of the profit made in high-return years, to soften the blow of low-return years.

Enhanced annuities. In exceptional circumstances, you may qualify for an enhanced annuity if you can demonstrate that your life expectancy is below average due to your ill-health or poor lifestyle choices. 

2. Living annuity 

The Living Annuity (LA) is, in essence, an investment product. It transfers the risk and responsibility of securing an adequate income for life onto your shoulders. In return, you have greater flexibility, more control over your financial affairs, and your heirs inherit whatever is left of your capital after your death (i.e. your capital does not die with you). In selecting a living annuity rather than a guaranteed annuity, you decide how to invest your savings. You can switch within the basket of investments offered by your product provider.

Every year you must draw a pension from your investment. This so-called draw-down must be at least 2.5% but no more than 17.5% of the annual value of the residual capital at the policy anniversary date. Your draw-down rate can change from year-to-year. Unless you have the necessary investment expertise, you should consult a reputable retirement planning tool or financial advisor on the appropriate draw-down rate and asset allocation. 

Your heirs inherit any residual capital after your death; they can choose to receive a lump sum, an ongoing annuity or an accelerated annuity (paying out over five years). Living annuities are offered by banks, collective investment schemes (such as unit trust management companies), life assurance companies and registered pension funds, but are classified as life assurance policies. You are entitled to switch between product providers at any stage, but you should do so only for sound reasons, such as an increase in costs, poor service or inappropriate investment choices. 

Living annuities are mainly sold through Lisps (linked-investment service providers). Lisps are essentially administrators who invest your money according to your instructions. They then track the performance of your investments. Lisps do not provide financial advice and you normally have to deal with them through a registered financial adviser. A living annuity is riskier than a guaranteed life annuity. 

A guaranteed life annuity will provide you with monthly income for the rest of your life. You have no such certainty with a living annuity as you assume the longevity risk (the risk that you last longer than your savings). 

Costs are an important consideration with any investment, and this is particularly true for a living annuity.

These products are potentially very expensive. Most living annuities charge initial fees, annual fees, transaction charges and investment management fees. The 10X LA only charges one annual investment management fee. The return you earn on your living annuity depends on how you invest your money (asset mix) and the returns generated by financial markets.