What is a living annuity?
At retirement from a pension, pension preservation or retirement annuity, you’re required to use at least two-thirds of the proceeds to purchase an annuity. You can choose between a life annuity and a living annuity.
The life annuity is an insurance product that guarantees you a certain level of income for the rest of your life. You don’t have to worry about outliving your capital or whether poor investment returns will erode your capital. The main drawback is that your capital dies with you, i.e. those income payments can’t be paid out to a beneficiary after your death.
In contrast, a living annuity is an investment product that relies on financial market returns to provide an income. You choose the underlying investments and take on the risk of generating enough income to see you through your retirement. This includes the risk that you outlive your capital or that your investments don’t produce the income you need to fund your lifestyle.
A living annuity gives you much greater investment and income flexibility; you can change your income level (within limits described below) and the frequency with which you receive payments to better manage your cashflow requirements. Furthermore, what’s left of your capital can be distributed to your heirs on your death.
What are the current regulations governing living annuity withdrawals?
Each year, you are allowed to draw between 2.5% and 17.5% of the market value of your annuity as your income. This can be paid out monthly, quarterly or annually but you can only change the amount you withdraw on a yearly basis (on the anniversary of your policy start date).
What are the new regulations?
For a temporary four month period between 1 June 2020 and 30 September 2020, you are able to change your drawdown rate (without having to wait until your policy anniversary as you usually would).
Furthermore, the withdrawal range has been extended to between 0.5% and 20%. From 1 October though, the drawdown rate will revert to that which you selected at the most recent anniversary date.
If, during the relief period, a policy anniversary occurs or a new contract is taken out and a “relief period” rate is selected, the annuitant can select a drawdown rate that will after the relief period is over (i.e. from 1 October).
These changes are temporary measures implemented to help living annuitant retirees in light of Covid-19’s effect on financial markets.
Should I take advantage of these changes and change my drawdown rate?
It depends on your personal circumstances.
Let’s assume you have a living annuity with a value of R5 million and a drawdown rate of 5%. If you take advantage of the 4-month dispensation and drop your income to 0.5% you would leave an additional R75 000 in your investment to recover and grow. On the flip side if you increased the income to 20% you would draw out an additional R250 000 and crystalize any losses. As an aside, increasing your income may also push you up a tax bracket so do your calculations first.
In general, increasing your drawdown rate is not advisable. Remember that these are your life savings and you need them to last as long as possible. What you don’t want to do is crystallise your losses when your investments are underperforming as a result of the market turmoil seen in 2020 so far. If volatile markets have left you cash-strapped or you need more income than usual in these strange times, first consider alternative options to dipping into your retirement money. A simple restructuring of your day-to-day expenses might leave you with the spare funds you need, for example.
First prize is to lower your drawdown rate to 0.5% if you can get by on slightly less income. This’ll just mean you are giving your savings more time to recover from the losses likely sustained in this year’s market falls. This is an especially desirable route if you have high equity exposure; lowering your income level will mean less erosion of your capital.
Speak to your adviser
Either way, we strongly advise that you discuss the options available to you given your unique situation and income requirements. They are best placed to help you decide on the route that’ll be most beneficial for you.
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