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Article 4

Difference between a conventional annuity and a living annuity

When you retire you stop working and your money starts working for you. It will be very important to consider the various investment options you will have. Although you are able to take your retirement benefits in cash it will be prudent to consider purchasing a pension from an insurer to make sure that your money last as long as you do.

It is recommended that you consult an accredited financial advisor who will be able to provide advice on the various products suitable to your needs. The final decision will be your responsibility and therefore we provide some information about the two main types of annuities available at retirement, a conventional annuity (guaranteed) and a living annuity.

Conventional annuity (Guaranteed)

When you buy a conventional annuity you are outsourcing the risk of living too long to the insurer. There are many types of conventional annuities but the most popular one is a With-Profit Annuity.

With-Profit Annuity

An annuity is purchased from an insurer and from it you will be paid a pension. The starting pension is guaranteed for the life of the principal member and when he/she dies a reduced pension for the life of the surviving spouse, if applicable, or if you have so elected.

The insurer determines your starting pension based on the amount of capital transferred, and your profile (factors including your age and that of your spouse, if applicable), and the Post Retirement Interest (PRI) rate. The PRI is effectively the minimum rate of interest (or investment return) that the retirement annuity fund must earn to cover the guaranteed annuity.

The insurer invests the assets in order to meet the contractual obligations to pensioners. For this type of annuity, the investment is generally a mix of bonds and equities which form a significant part. The equity element brings the potential for higher investment returns, which then translate into declared bonuses. If the net smoothed investment returns are say 9%p.a and the PRI rate is say 4% then the insurer will be able to grant increases of the difference (9% less 4%) i.e. 5% p.a. The improved pension resulting from the increase is also guaranteed for life.

There is no guarantee that increases will keep pace with inflation. Everything depends upon the performance of the underlying investments. Increases are "smoothed" which means that in times of good investment performance insurers hold back some of the returns and use these in times of low returns. The objective is to provide consistent increases.

Good points about a With-Profit Annuity are:

  • Pension cannot reduce;
  • Insurer manages the investments.

Negative points of a With-Profit Annuity are:

  • Annual increases are based on investment performance, so you are sharing some of the risk
  • Annuity ends on last person dying;
  • Once you have invested you cannot change to any other annuity.

Living Annuity

A living annuity is simply an investment account from which you withdraw an income. The amount withdrawn is limited by SARS to a range of from 2,5% to 17,5% of capital per year. Income is usually drawn in monthly payments like a pension, although other payment options exist. The withdrawal rate can be changed once a year on the anniversary date of commencement. When you die, the residue can be left to a spouse or children, depending on who survives, failing which it goes to your estate.

With a living annuity you enjoy all the rewards of successful investment, but you also carry all the risk that this may not be the case. It is important that these risks be thoroughly understood. They are:-

  • There are no guarantees of any sort;
  • You may withdraw too much too soon;
  • You may live longer than expected; Your investment may not perform well;
  • The market may decline dramatically.

The net effect of this is that secure increases in income depend entirely upon investment performance and the rate of your withdrawals. Income can of necessity decrease if the capital value drops too low.

Unlike a pension from a pension fund or guaranteed annuity, where your pension is guaranteed for however long you live, irrespective of market conditions, in a Living Annuity you cannot afford to consume all your capital too quickly in case you live longer than expected - unless you have other sources of income.

Good points of a Living Annuity are:

  • If you die, and there is money left it can go to your children;
  • You can choose your own pension amount;
  • If you are not happy with the product you can move your money to any other annuity.

Negative points:

  • Low increases due to poor investment performance;
  • Pension too high when you start causing your money to run out.


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