Retirement vs living annuities – what’s the deal and what’s the difference? While both are intended to fund your post-working years, they become relevant at different times of your life. When it comes to saving for retirement, a misconception seems to have arisen from an over-emphasis on the different phases of retirement. Too much focus has been placed on differentiating pre-retirement savings from post-retirement funding, with the result that the middle time period has been almost completely overlooked. Let’s take a look at retirement annuities and living annuities, and when you should be considering each, in order to paint a clearer picture of your financial future.
Annuities
What is a retirement annuity (RA)?
A RA is a tax-effective pre-retirement investment, which is designed to allow people to save during their working career for their golden years. RAs are generally used by contractors, entrepreneurs or freelancers to save, as it is an investment option that is not linked to employment. It can also be used in conjunction with an existing pension or provident funds that an individual participates in through their employer.
When should you consider investing in a retirement annuity?
As mentioned, a retirement annuity is an extremely tax efficient way of saving for your future while you are still working. All or a portion of your contribution may qualify for a tax deduction which ultimately reduces your tax bill, while growth in the RA is tax free. Furthermore, because these savings can only be accessed from the age of 55, it is not money that you can touch or spend. This reinforces your saving discipline. Even better, these funds have immunity from creditors, which means that if you get into bad debt, your creditors cannot go after your retirement savings.
What is a living annuity?
A living annuity (LA) is, in essence, an investment product. It is a post-retirement investment product that transfers the risk and responsibility of securing an adequate income for life to you, giving you greater investment and income flexibility in return, and allowing you to provide for your dependents after your passing, in that your heirs inherit the remainder of your capital.
When should you consider investing in a living annuity?
Upon retirement from your RA, pension fund, provident fund or similar retirement saving fund, you will be required to spend two-thirds of your savings on purchasing a living or life annuity. In other words, a living annuity does not come into play before the age of 55.
What are the Living Annuity rules you need to be aware of?
- A living annuity can only accept proceeds from a retirement fund or another living annuity. In other words, you cannot top up a living annuity with cash funds.
- You can add the proceeds from a retirement fund to your existing living annuity or you can transfer your living annuity from one service provider to another but you cannot combine two living annuities into one.
- You must draw a pension income from your LA investment. This is known as a draw-down, and it must be at least 2.5% but no more than 17.5% of the annual value of the residual capital at the policy anniversary date.
- Your draw-down rate can change annually but you must make your election before the policy anniversary date.
- You can choose to receive your income monthly, quarterly, semi-annually or annually.
Previously, LAs were attractive to retirees due to the restrictions imposed by Regulation 28 of the Pension Funds Act, in terms of which there was an offshore exposure limit of 30% for retirement or pension investment vehicles. This left investor returns vulnerable and exposed to the volatile performance of the South African market. Investing in a LA was an effective way of getting around these Regulation 28 restrictions, as living annuities allow for 100% offshore exposure. Although these restrictions have been raised to 45% permissible offshore exposure, where this is insufficient for an individual investor, choosing a living annuity is the best way to go.
Misconceptions about saving for retirement
When it comes to investment planning for retirement the two main phases are ‘pre-retirement’ and ‘post retirement’. There is a big gap between these in consumer awareness, which has given rise to much confusion. Individuals generally assume that a retirement annuity is only for ‘pre-retirement’, and a living annuity is only for ‘post retirement’. This is not accurate. The assumption is that as an individual investing in a retirement annuity, you must first retire from employment, which for most people, happens around the age of 60 – 65. Once you have reached this age and stopped working, only then can you retire from your retirement annuity and only then can you purchase a living annuity.
This is not the case. Once you have reached the age of 55, regardless of whether you are still working or not, or when you plan to retire, you become eligible to retire out of a retirement annuity. At this point (purely on an age basis) you will be able to withdraw your RA savings, and you can choose to take one-third as cash and use the remaining two-thirds (or the full amount, if you choose not to make a lump sum withdrawal) to purchase a living annuity.
To recap, the key differences between a retirement annuity (RA) and a living annuity (LA) are:
- You can get a retirement annuity now but you can’t touch it until the age of 55, or illness or permanent disability.
- A retirement annuity is a savings vehicle governed by the Pension Funds Act with certain restrictions.
- When you reach the age of 55, you have the option of buying into a living annuity using the proceeds of your RA.
- Living annuities are governed by the Long Term Insurance Act which has different rules around offshore asset exposure.
- A living annuity pays out an income according to your specifications – drawdown rate and frequency. Pension paid out from a LA is taxable.
- If you relocate abroad permanently, you can transfer the monthly, quarterly, semi-annual or annual income derived from the LA abroad.
- . An RA can be cashed in and once you’ve paid the taxes and early withdrawal penalties, you can move this money overseas.
FinGlobal: retirement annuity encashment specialists
Looking for assistance in cashing in your retirement annuity because you’ve emigrated from South Africa permanently? You’ve come to the right place. We can help you every step of the way – from starting the tax emigration process and getting tax clearance, all the way to transferring your RA proceeds out of South Africa.
To get started, please leave us your contact details and we’ll be in touch to discuss the next steps.