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Guaranteed retirement annuity vs living annuity explained

A Fin24 user is a year from retirement and wants to know which product could provide her with an income as well as pay for her son's studies. She writes:

I am 64 years old, a single woman and one year from retirement.
I have R2m in a provident fund and R400 000 in a retirement annuity. My house is paid up and I have no other debt.
However, I have an 18-year-old, who will be going to university next year. I will be fully responsible for his fees and upkeep.
I want to put the funds in a facility that will give me a liveable monthly income when I retire. There have been no withdrawals from the funds since 2003.
I am looking at a facility that would provide income for the next 25 years after retirement.
What would be the tax implications?
Tracy Jensen, head of product at 10X Investments, responds:
There is quite a lot of information to consider, so I have only given an outline in my response.
It would be very beneficial for you to generate a more detailed financial plan to give you a better understanding of your options. You can do this here and there is no cost to generate the plan.

There are two main products that can provide you with an income from your retirement savings.
The first is an insurance-type product called a guaranteed annuity and the second is an investment-type product called a living annuity. Each of these meets different needs so you will need to decide which will best meet your particular goals.

A guaranteed annuity secures you a pre-determined income for the rest of your life. There are different types of guaranteed annuities.
Some provide an income that increases with inflation, others pay a level income and others yet may increase over time, subject to market returns. For the purposes of this discussion, I have assumed that you will consider an inflation-linked guaranteed annuity, which provides an income that keeps pace with inflation.

Although your income is guaranteed for your whole life, your heirs won't be able to inherit whatever is left on the death.
In other words, the capital dies with the investor. However, in order to ensure that your 18-year old is provided for, you could consider purchasing a guaranteed annuity that will pay an income for a certain number of years regardless.
This period is called a guarantee period. An annuity with a guarantee period will pay a lower retirement income than one without a guaranteed period.
Typically, you also have no say over the initial income and no flexibility to change your income or to move to another annuity or service providers once you've purchased the product.
On the other hand, a living annuity provides investors with flexibility to choose their income each year (subject to regulatory limits) and where their money is invested.
This will give you the flexibility to draw a slightly higher income, while supporting your 18-year old at varsity, and reduce it later. It will provide you with the flexibility to change service providers or purchase a guaranteed annuity at any time.
Any remaining capital upon death passes to your heirs. However, in exchange for this flexibility, you take on the risk that the income may not last for the 25 years you desire, as well as the risk that their investment returns are poor.
This means that your future income could fail to keep up with inflation, or even that investors outlive their savings.

Below is a table summarising the difference between an inflation-linked guaranteed annuity and a living annuity:
(10X Investments)
Guaranteed annuity estimated income
An inflation-linked guaranteed annuity will provide you with a monthly income of approximately R12 300. However, there is no guarantee period so you may wish to consider a guaranteed annuity where income is paid for a certain period regardless. This will provide you with a lower income.

Living annuity estimated income
There are three important decisions you need to make in a living annuity. Where to invest your money, what total fees you are willing to pay and the income you should draw. Each of these affects your outcome.
The table below shows you the income that you could sustain for 25 years, assuming an inflation increase in your income each year. It is shown for different investment portfolios (low equity, medium equity and high equity) and for different fees.
There are low fees (0.586% including VAT as a percentage of investment value per annum) and the average industry living annuity fees (2.85% including VAT as a percentage of investment value per annum).

In the case of a high equity portfolio paying low fees, you could sustain a monthly income of approximately R12 200 growing with inflation for 25 years, thereafter your income would no longer be able to keep pace with inflation.
You would still have money in your account in this example, but regulation restricts your income to a maximum of 17.5% of your investment value so you would not have sufficient funds to increase your income with inflation.
This income is, however, not guaranteed and depends on your investment returns. For example, if markets are poor then a high equity portfolio paying low fees may only sustain a monthly income of about R9 800 growing with inflation for 25 years.
Tax
At retirement you may cash in up to 100% of the value of your provident fund and up to one-third of the value of your retirement annuity.
However, there are potentially tax implications to taking a portion in cash. The table below shows you the tax rates for various cash amounts taken at retirement.
In addition to the tax above, the income you receive from either a guarantee or living annuity would be taxed as per the applicable income tax table.