Is a fixed or living pension more profitable?

Dear reader,

Thank you for your question.

Upon retirement, legislation stipulates that you can take one-third of the remaining funds in your pension, provident, or retirement annuity fund as a cash lump sum, and two-thirds must be used to obtain a compulsory annuity (life annuity, a living annuity, or a combination of both). This rule applies to each retirement fund, even if you have previously made withdrawals from a retirement fund. However, it’s important to note that if you have already utilised the tax-free portion of R550 000 with your initial withdrawal, it may not be available for subsequent withdrawals.

Furthermore, if your fund balance is less than R247 500 at retirement, you can choose to take the full amount as a cash lump sum.

Understanding the concept of vested and non-vested benefits at retirement is crucial. As per legislation, a vested benefit refers to the amount that can be withdrawn as cash upon retirement for individuals who were part of a provident fund before 1 March 2021. Conversely, if you are below 55, any contributions made to provident funds after 1 March 2021 will be regarded as non-vested benefits, thereby becoming subject to the annuitisation rules when you retire.

Life/fixed annuity

Many clients require a monthly income for life throughout their retirement years. A life/fixed annuity is an insurance product that provides a guaranteed income stream for the duration of the annuity contract. This means that retirees can rely on a steady and predictable income throughout their retirement years, regardless of market conditions or fluctuations.

However, there are a few drawbacks to this retirement product, which contribute to why advisors might not recommend this product.

You cannot nominate a beneficiary or beneficiaries, so when you pass, your loved ones will not get anything.

However, this retirement product offers a guaranteed option for a specific period, such as 10, 15, or 20 years. During this time, you can nominate beneficiaries who will receive the promised monthly payments until the end of the specified period, even if you pass away. The monthly payments are subject to income tax as per the Sars tax tables. It is worth noting that choosing the guaranteed option will result in a reduction in your monthly payments. Furthermore, this retirement product does not form part of your estate.

When you purchase a life annuity, you transfer the risk of outliving your savings to the insurance company. As a result of this, they will calculate the monthly payouts based on the total amount invested and the payout rates. As the annuitant, you have no control over the payment amount. Moreover, the impact of inflation on the promised monthly payments is not explicitly stated, exposing the annuitant to inflation risk.

Living annuity

When looking at your situation where a monthly income is not needed, we suggest investing in a living annuity. A living annuity is a type of retirement income product that provides individuals with flexibility in managing their pension funds. It allows retirees to withdraw a regular income from their accumulated retirement savings while keeping the remaining funds invested in various assets such as equities, bonds, property, income and money-market funds.

With a living annuity, you have control over how your funds are invested and how much income you withdraw annually, within certain limits of 2.5% to 17.5% per annum.

This flexibility allows you to adjust your income based on your changing needs and market conditions. However, if an individual draws an income higher than the recommended drawdown rate and more than the growth of their investment, they could risk eroding their capital. Furthermore, each year on the anniversary of the living annuity, it is possible to adjust the income drawn, providing the opportunity to choose between a higher or lower amount.

With a living annuity, the growth of your investments directly impacts the income you receive. If your investments perform well, your income may increase over time. This growth potential can be particularly advantageous for retirees with longer life expectancies who want their funds to last throughout their retirement.

In a living annuity, you can choose from a range of investment funds, such as equities, bonds, property, income and money-market funds.

This control over investment decisions allows you to potentially earn higher returns, although it also carries higher investment risk.

By actively managing your investments, you have the opportunity to grow your retirement savings.

Living annuities offer the opportunity to leave a legacy for your beneficiaries. Any remaining funds in the annuity after your death can be passed to your nominated beneficiaries, subject to taxation and the annuity provider’s specific rules. This feature allows you to preserve and transfer wealth to your loved ones.

You may also consider utilising the income from the living annuity to invest in a unit trust. Investing in a unit trust presents advantages such as diversification, the flexibility to buy and sell units, and affordability, as many unit trusts only require a minimum investment amount of R50 000 or a recurring debit order of R1 000. Furthermore, unit trusts are overseen by competent fund managers with the expertise to manage these investments effectively.

In conclusion, the best option would be to invest in a living annuity since it has better flexibility and control, more potential for growth, allows legacy planning and carries higher risk, which could lead to higher returns. However, we strongly recommend seeking guidance from a financial advisor who can assist you in structuring your portfolio based on your objectives and risk tolerance.