173 - Life annuities: weighing out the options

Question:

I’ll be turning 58 in just over a week's time. I have my pension money in a preservation fund until age 65.  Herewith are a few questions: 1. I would like to draw an income but as I only turn 65 in 7 years time, is a Life Annuity recommended? 2. Can a Life Annuity be structured to include a beneficiary who is not a spouse?

Answer:

Even though you set a retirement date of 65 when you took out your preservation fund, you may retire from that fund at any stage from the age of 55. As you are 58, you may retire from this fund immediately.

If you have not made a withdrawal from this preservation fund, you may take out R 25,000 as a tax free withdrawal.  This is advantageous as any income from this lumpsum will only be taxed as a capital gain which is taxed at a lower rate.

If you then retire from this fund, you may take out up to 1/3 as a lump sum and the balance must be used to purchase an annuity. The lump sum that you take will be taxed according to play special table for lump sum withdrawals from a pension fund.

Life annuity

There are a couple of factors that played key role when it comes to calculating the amount of income that you can get from a guaranteed life annuity.  The two key variables are the prevailing long bond rates and your age. 

The long bond rates have been decreasing over the past couple of weeks but they are still significantly above the pre-covid levels.  We do not know what they will be like in 7 years’ time if you retire at 65.

To illustrate the impact that age makes, here is an example of a 58 year old and a 65 year old investing R1 million into an annuity: 

While you are getting a higher initial annuity when you get older, the life annuity still represents good value for a 58 year old as you are locking in a return of 11% for the rest of your life.

In terms of income, if you invested in a living annuity, you should be drawing down no more than 4% a year as a 58 year old.  So, for a R1m investment, a sustainable monthly income would be around R3 300 as opposed to the R6 500 that a life annuity would give you.

Joint life annuities

You can take out a joint life annuity that will pay out an amount until the last person dies. This person need not be your spouse. You can have a joint life annuity with someone who is not your spouse. Remember that the starting pension will be impacted by the age and gender of the second life.  If the second life is younger than you are or if the second life is a female the starting pension would also be lower because females live longer than men.

When the first person passes away, you can have the annuity remain the same or reduce to 50% or 75% of the current amount . The size of the decrease will impact on the starting amount that you receive.

You need to ensure that you have sufficient income to meet your long term needs. Remember that one in ten of us are going to live to 100, so your pension needs to be robust enough to last for another 40 years.  I would recommend but you get some specialist advice before making any big decisions. 

Kenny Meiring MBA CFP ® is an independent financial adviser who helps people put investment and risk structures in place to live wonderful lives.  You can contact him on 082 856 0348 or at Financialwellnesscoach.co.za. Please send your questions to kenny.meiring@sfpwealth.co.za