Question

I will be retiring at the end of the year and need to decide on what type of annuity I take. Here are the key details:

• I have around R4 million available after I take my lump sum.
• My wife has no savings so my retirement fund must support her for the rest of her life. (She is 10 years younger than I am).
• We’re helping my daughter out and I would like to leave her something when we both pass away.
• We will need an after-tax income of around R18,000 a month.

Answer

I often come across situations where one spouse does not have sufficient retirement savings to support themselves.  There are also many retired people who are supporting adult children and their families. While this adds a level of complexity to the retirement planning, in most instances, we are able to come up with a workable solution.

I will run through a couple of the options that are available and go through the pros and cons of each.

Living annuity

With a living annuity, you make a withdrawal from your retirement fund each month and use that to live on. This drawdown must be between 2.5% and 17.5%.

If your drawdown is higher than the growth on the investment and its running costs then you will start using up the capital and could be in a situation where you run out of money. 

What is nice about the living annuity is that your wife would inherit the annuity should you pass away. When she passes away, your daughter would inherit.

The recommended drawdown rate for a 65-year-old is 5% so it would give you an after-tax income of R15 890 a month.

This is below the R18 000 a month that you need so we need to consider an alternative.

Life annuity

A life annuity is a series of payments for the rest of your life that you buy with your retirement savings. In your instance, you would need a series of payments that that will be paid till both you and your wife have passed away.

What is nice about a life annuity is that the income you get will often be about 50% higher than that which you can responsibly take from a living annuity. 

R4 million will provide an after-tax monthly income of R21 895, increasing each year till you and your wife pass away. 

This is more than the R18 000 a month that you need.

The downside of a life annuity is that when the last life has passed away, there is no capital amount available for inheritance.  This will provide you with the right after-tax income but there will be nothing for your daughter to inherit.

Capital preservation annuity

This is a special type of life annuity which pays out an annuity until the annuitant dies.  When the annuitant dies, the initial investment amount is paid out to the beneficiaries

This type of annuity is useful when you need a high income for the surviving spouse or an income or capital amount for an adult child or grandchild.  I like to use this instead of joint  life annuities when the age gap between spouses is larger than 7 years.

The way this product works is that you receive a monthly income that increases by a fixed percentage until you die. When you pass away, your beneficiaries will receive your original capital back.  This capital can then be used to provide a monthly income for your wife as well as a decent inheritance for your daughter.

A R4 million capital preservation annuity will give you an after-tax income of R20 058 increasing by 5% a year for the rest of your life. 

When you pass away your wife will receive R4 million that she can use to provide herself with an income.  And leave a decent amount of money to your daughter as an inheritance.  This looks like an option to consider.

As you can see, there are several moving parts when it comes to constructing a retirement solution and I would recommend that you speak to a financial advisor before making a final decision.