• Bruce Cameron

Living Annuity vs Death Benefits: A tough balance

The more income you require from an investment-linked living annuity the less the death benefit you will receive. As one goes up, the other goes down. What that means is that benefits for heirs are seldom achieved.

Last week I dealt with some of the pros and cons of living annuities based on the table below used by product providers. Today I will deal with the issue of ensuring income lasts for life and flexibility. Next week I will write about leaving money to an estate and costs (which are not included in the below table).

The table, prepared by the linked investment service provider (Lisp) companies, has in the past been used to promote sales of living annuities.

The sustainability of income in retirement is the biggest challenge for Lisps in selling living annuities.

There are two main reasons why a living annuity does not necessarily last for life. You need to make very careful decisions. The reasons are:

  • Your future income, which will depend on how much you withdraw from your capital.

  • In terms of legislation, your living annuity pension drawdown must be between a minimum of 2.5% up to a maximum of 17.5% of the value of the residual capital (after the withdrawal of income and the deduction of all costs over the previous year).

You can only make this change on the anniversary date each year.

You need to decide on the level of your drawdown (pension) at the start of your investment, then review the drawdown amount annually.

What you must avoid is the “point of ruin”. This is when you have reached the maximum drawdown rate of 17.5% and your annual rand income starts to decrease.

The international research data company Morningstar published research in 2016 based on market returns in a number of countries, which showed that if South African residents want a 99% chance of having a sustainable income that keeps up with inflation, they should draw down no more than 3.3% of their capital.

For a 70% chance, this should be no more than 4.1%; and if they want better than a 50% chance, they need to keep their drawdown to below 4.5%. This does not take account of increases in income for pensioners for age changes, so it will be more conservative.

Actuary John Anderson, who heads research at Alexander Forbes, the largest retirement fund manager in South Africa, says recent research on records held by Alexander Forbes shows that drawdown rates have now increased to unsustainable levels and that the Covid-19 crash will make it far worse.

Covid-19 has, however, created a once-off opportunity for pensioners to adjust their drawdowns. SARS says “individuals who receive funds from a living annuity will temporarily be allowed to immediately either increase (up to a maximum of 20% from 17.5%) or decrease (down to a minimum of 0.5% from 2.5%) the proportion they receive as annuity income, instead of waiting up to one year until their next contract “anniversary date”. This will assist individuals who either need cashflow immediately or who do not want to be forced to sell after their investments have underperformed.

This will only become act