Old Mutual retirement warning

South Africans saving for retirement often focus on how much they have to put aside for retirement and whether that will be enough money to sustain their lifestyle when they stop working. 

However, an increasing issue is what type of annuity products they choose in retirement to generate an income that can sustain their lifestyles. 

This is potentially a significantly more important decision when it comes to retirement, with there being different types of annuity products to choose from, and with some, once a choice has been made, it cannot be undone.

Much focus over the past year has been on the potential pitfalls of withdrawing funds from retirement savings early under the new two-pot retirement system.

Experts have urged individuals to avoid withdrawing large sums or on a consistent basis, unless it is in case of an emergency, as early withdrawals will disrupt the compounding process and worsen financial outcomes in retirement.

However, the new two-pot system introduces some flexibility, with individuals able to make up the lost compounding from early withdrawals by increasing contributions later. With an annuity product, some decisions cannot be undone.

Old Mutual Personal Finance senior financial advisor Kamal Patel urged South Africans entering retirement to thoroughly understand their annuity options.

“What you choose will depend on a number of factors, the most important of which are – how much you have saved, how long you expect to live in retirement, how comfortable you are with investment risk, and whether you would like to leave capital for your heirs,” he said.

Regarding savings in a retirement fund, such as a pension fund, provident fund, preservation fund, or retirement annuity, there are certain rules that apply. 

“If the fund value is more than R247,500, only one-third may be withdrawn as cash, of which the first R550,000 is tax-free,” Patel said. 

“The remaining two-thirds must be used to purchase an annuity, which will provide you with a monthly income subject to tax.”

The options

Patel said there are two basic types of annuities, although providers offer variations on each. Individuals are not limited to one, with many choosing a combination of both. 

The first major type is a life or guaranteed annuity, which is a pension bought with your savings from a life insurance company, where your monthly income is determined at inception and paid for life – the risk lies with the insurer. 

You may choose a level annuity or, at a lower initial income, opt for an annual escalation of, for example, 5% to keep pace with inflation, Patel explained. 

You can choose between a single-life annuity, where the income is paid to you for the duration of your life, or a joint and survivorship annuity, where the income continues to a second person after your death. 

However, choosing the latter option generally reduces your initial income as the insurer has to handle additional risk.

The annuity may also include a guarantee period, which ensures that the income continues to be paid to a nominated beneficiary if you pass away within that period. 

For example, suppose you select a ten-year guarantee period and live beyond the ten years. In that case, the income will continue to be paid to you for as long as you live, but no further payments will be made to your beneficiaries after your death. 

However, if you pass away in year five, the income will continue to be paid to your nominated beneficiary for the remaining five years, ending at the conclusion of the ten-year guarantee period.

Another life or guaranteed annuity is a “with-profit” annuity, whereby your savings are invested in market-linked portfolios. 

The insurer will guarantee a minimum income. However, any increases will depend on investment performance.

“It’s important to note that a life annuity is, literally, for life. You cannot opt out or transfer your savings to a different product once you’re in it,” Patel warned.

“You also need to understand that, outside the guarantee period, there is typically nothing left over after your or your surviving spouse’s death”.

A second option is a living annuity, which is an investment portfolio where your income is derived from the returns generated by the underlying assets. 

You can choose from a range of funds on the provider’s platform, which are subject to fluctuations in financial markets, Patel explained. 

Once a year, on the anniversary of your inception, you decide what percentage of your capital to withdraw as income, ranging from 2.5% to 17.5%. 

However, the higher the percentage you withdraw, the faster your capital will deplete.

“In a living annuity, you take on the responsibility of ensuring that your pension lasts for life. It is therefore essential that you manage it with the ongoing guidance of a trusted financial adviser,” Patel said.

“An advantage of a living annuity is that you can transfer to another living annuity or to a life annuity at any time.” 

“In addition, any remaining capital still invested in the living annuity at the time of your death will be distributed to your beneficiaries, subject to certain conditions.”

As you approach retirement, take the time to carefully review your income options, Patel urged. The right annuity choice depends on your unique circumstances, including your income needs, health, lifestyle goals, and risk tolerance.

A life annuity can offer peace of mind and certainty through a guaranteed income, while living annuities offer flexibility and growth potential but also require active management.