Question

I am 81 years old and have a living annuity worth R2.1 million from which I am currently drawing a pension of 15%.  I have just received a notice from the company that pays the annuity indicating that my income for the coming year will be quite a bit less than what I received last year. What can I do?

Answer

A living annuity works as follows: you invest an amount of money with the company.  The capital should grow each year with its investment returns. Now, as long as the investment growth is higher than the drawdown you are making as well as any running costs on that investment, the income that you receive should increase each year. If the drawdown and costs are higher than the investment growth, your income will decrease.

The typical running costs for a living annuity come to around 2% so when we add your 15% drawdown to this, your investment must return more than 17% to prevent you from having to use up some of your investment capital to subsidise your monthly income.  As your investment capital will be lower at the end of the year, the 15% drawdown that you make will result in a smaller monthly income.  This trend will continue till you run out of money. 

It is therefore important that your drawdown not be so large that you run out of money.  The FSCA published guidelines drawdown rates to ensure that you don’t run out of money.  These are given below:

Your 15% drawdown is way more than the recommended drawdown rate of 6%.

15% of R2.1m would give you a monthly income of R26 250 which will decrease each year till the capital runs out.

The recommended drawdown of 6% will give you an income of R10 500 which will last you for the rest of your life.  There is quite a gap between what you are currently getting and what income would be sustainable so we need to look for an alternative solution.

An option to consider is a guaranteed life annuity.  If you convert your living annuity into a guaranteed life annuity, you can get a monthly income of R21 600, increasing by 5% a year for the rest of your life.  While this is not at the same level as that which you are currently receiving, it is sustainable, will increase and be paid for rest of your life.

You must remember that with a guaranteed life annuity, should you pass away, there will be nothing for your heirs to inherit.  However, had you continued with the high drawdown on the living annuity, there would also have been nothing to inherit and you would have run out of money while you are alive.

I would recommend that you look at reducing your monthly expenses and consider using a guaranteed life annuity to provide a sustainable and increasing pension for the rest of your life.