Living Annuity or Life Annuity: The Retirement Decision With a Once-a-Year Lock

At retirement, most people face one decision that cannot be taken back, and they usually make it in a fortnight, under time pressure, with a form in front of them.

Two-thirds of what sits in a pension or retirement annuity fund must be used to buy an income. The choice is between two very different instruments, and the difference is not really about returns. It is about who carries the risk that you live longer than the money.

Neither is the right answer in general. But one of them contains a constraint that surprises almost everyone, and it is worth knowing before you sign rather than eleven months afterwards.

What has to be annuitised

On retirement from a pension, pension preservation or retirement annuity fund, you may take a maximum of one-third of the retirement interest as a cash lump sum. The remaining two-thirds must be used to provide an annuity.

There is one exception worth checking first: if your total retirement interest in the fund does not exceed R247,500, you may take the whole amount as a lump sum. Below that line the annuitisation requirement falls away entirely.

Above it, you choose between a guaranteed life annuity and a living annuity — or a combination of the two, which is permitted and often overlooked.

The two instruments, honestly described

A guaranteed life annuity is a purchase. You hand capital to an insurer and it pays you an agreed income for as long as you live. The insurer carries the risk that you live to 100. Your income does not fall if markets fall. In exchange, the capital is generally gone — what happens on death depends on the specific structure you buy, such as a guaranteed payment term or a joint arrangement covering a partner, and those features cost income.

A living annuity is a portfolio you draw from. The capital stays invested in your name and you choose how much to withdraw within prescribed limits. You keep the investment upside. You also carry the investment risk and the longevity risk — if the fund runs down, the income runs down with it. Any balance remaining passes to your nominated beneficiaries.

Put plainly: a life annuity converts capital into certainty. A living annuity keeps flexibility and control, and keeps the risk.

The drawdown band

For a living annuity contract concluded on or after 21 February 2007 — which covers essentially every current contract — the annual drawdown must be not less than 2.5% and not greater than 17.5% of the value of the assets.

Contracts concluded before 21 February 2007 run on a band of not less than 5% and not greater than 20%, and may be moved onto the newer band if the annuitant agrees to be bound by those income levels and any later adjustments.

At inception the percentage applies to the investment amount net of costs, not the gross figure.

The once-a-year lock

Here is the constraint that catches people, stated plainly in the notice.

You elect your drawdown percentage at inception. On the anniversary date of inception, the fund is revalued, the new minimum and maximum are calculated, and you may elect a different percentage within the limits.

And then: "The annuitant may not elect a different draw-down percentage at any other time."

So the decision is annual and it is locked. If markets fall three months in, you cannot reduce your percentage to preserve capital until the anniversary. If your costs rise unexpectedly, you cannot increase it either. Whatever you choose has to survive twelve months of whatever happens.

Two things follow. Choose the percentage against a realistic year, not a hopeful one. And diarise the anniversary date, because it is the only day of the year on which this decision is available to you.

The percentage is of a moving number

The other half of the arithmetic is easy to miss. The band applies to the revised fund value at each anniversary, not to your original capital.

That means a fixed percentage does not produce a fixed income. If the fund falls, the same percentage produces less money next year. If you respond by raising the percentage to maintain your income, you draw a bigger slice of a smaller pot — which is the mechanism by which living annuities fail, and it accelerates.

It also means the maximum is not a target. Drawing near 17.5% may be sustainable for someone in their eighties with a short horizon and no dependants. Applied at 60, it is a plan for running out.

If you move the annuity

Living annuity contracts can be transferred between insurers, or from a retirement fund to an insurer. The notice preserves the same anniversary and election rules on transfer, and adds two constraints: the frequency of payment may not be changed, and the annuity may not be split so that more than one annuity is payable after the transfer.

Worth knowing before you move, because the flexibility people expect from a transfer is narrower than assumed.

What actually decides it

Strip away the product marketing and the question is a personal one.

How much certainty do you need at the bottom? If a fall in income would be genuinely unmanageable — because there is no other pension, no other capital, no other earner — the guaranteed structure is doing something a portfolio cannot.

How long might you live? Longevity is the risk people systematically underestimate. A life annuity transfers it to an insurer. A living annuity leaves it with you.

Is there capital you want to pass on? A living annuity balance goes to your beneficiaries. That matters to some people a great deal and to others not at all, and it should be weighed honestly rather than assumed.

Can you live on the sustainable drawdown? Work out what a conservative percentage of your actual fund produces monthly, before tax. If that number does not cover your life, a living annuity does not fix it — it postpones the problem and makes it worse.

Combining the two is permitted, and for many people a guaranteed income covering the non-negotiable costs, with a living annuity for the rest, resolves more of the tension than choosing a side.

What to do

1. Check the R247,500 line first. Below it the annuitisation requirement does not apply at all.
2. Get the sustainable number before choosing a product: what does a conservative percentage of your fund actually pay per month?
3. Note the anniversary date if you take a living annuity. It is your only opportunity each year to change the drawdown.
4. Understand the fees, since they come off the same capital that has to last. Our retirement planning calculator lets you model the fund side.
5. Ask what happens on death under each option you are shown, in writing, and what any guarantee or joint feature costs in income.
6. If your fund is small, ask whether a commutation threshold applies to it. Such a threshold exists and has been revised over time, so confirm the current figure with your provider rather than relying on a number from an article.
7. Get advice for a decision of this size, and be clear about how the adviser is paid.

If you are still accumulating rather than drawing, our two-pot guide and withdrawal calculator cover what leaving money invested is worth. For everything else, start at our money guides.

Frequently asked questions

How much of my retirement fund must be annuitised? Up to one-third may be taken as a cash lump sum, and the remaining two-thirds must provide an annuity — unless your total retirement interest in the fund does not exceed R247,500, in which case the full amount may be taken as a lump sum.

How much can I draw from a living annuity? Between 2.5% and 17.5% of the value of the assets each year for contracts concluded on or after 21 February 2007. Contracts concluded before that date run on a 5% to 20% band and may be moved to the newer one.

Can I change my drawdown percentage during the year? No. You elect it at inception and may change it on the anniversary date of inception. The notice states the annuitant may not elect a different percentage at any other time.

Is the percentage applied to my original capital? No. It is applied to the fund value as revalued at each anniversary, so the same percentage produces a different amount as the fund moves. At inception it applies to the investment amount net of costs.

What is the difference between a living and a guaranteed life annuity? A life annuity pays an agreed income for life, with the insurer carrying the longevity and investment risk. A living annuity keeps the capital invested in your name, leaves those risks with you, and passes any balance to your beneficiaries.

Can I have both? Yes. Combining a guaranteed income for essential costs with a living annuity for the rest is permitted and is often more useful than choosing one outright.

What happens if I transfer my living annuity to another insurer? The same anniversary and election rules continue to apply, the frequency of payment may not be changed, and the annuity may not be split so that more than one annuity is payable after the transfer.

Can a small living annuity be paid out in cash? There is a value threshold below which commutation is permitted, and it has been revised over time. Confirm the current figure with your provider before relying on it.