Life Annuities vs. Living Annuities in South Africa: A Simple Comparison

Life Annuities vs. Living Annuities

When planning for retirement in South Africa, choosing the right annuity can significantly impact your financial stability and peace of mind. Two popular options are life annuities and living annuities. Here’s a straightforward comparison to help you understand their key differences, with relatable examples to make things clearer.

What are Life Annuities?

Life annuities are financial products that provide you with a guaranteed income for the rest of your life. You purchase a life annuity from an insurance company using a lump sum of money, typically your retirement savings. In return, the insurance company pays you a fixed monthly income.

Key Features of Life Annuities:

• Guaranteed Income: You receive a fixed income for life, regardless of how long you live.
• No Investment Risk: The insurance company takes on the investment risk.
• No Access to Capital: Once you purchase a life annuity, you cannot access your lump sum again.
• Inflation Protection: Some life annuities offer an option to increase your income in line with inflation, but this usually reduces the initial income amount.
• Guaranteed Period: You can choose a guaranteed period (e.g., 10 or 20 years). If you pass away during this period, your beneficiaries receive payments for the remainder of the period. If you live beyond the guaranteed period, payments continue for life, but nothing is left for beneficiaries after your death.

What are Living Annuities?

Living annuities allow you to invest your retirement savings in a range of investment funds. You can choose your level of income each year, subject to regulatory limits, and your capital continues to grow or decline based on investment performance.

Key Features of Living Annuities:

• Flexible Income: You can choose how much income to draw each year, between 2.5% and 17.5% of your investment value.
• Investment Control: You have control over how your money is invested, allowing potential growth.
• Investment Risk: Your income depends on investment performance, so there’s a risk your capital may decrease if investments perform poorly.

Comparing Life Annuities and Living Annuities

1. Income Security

• Life Annuities: Provide a secure, predictable income for life.
  Example: Think of it like a monthly salary from your job. No matter what happens in the economy or the markets, you know you will get the same amount every month.
• Living Annuities: Income can fluctuate based on investment performance and your chosen drawdown rate.
  Example: It’s like running your own business where your income can vary each month depending on how well the business does.

2. Investment Risk

• Life Annuities: The insurance company bears the investment risk.
  Example: Imagine having a contract where your salary is fixed, and the company is responsible for ensuring they have the funds to pay you.
• Living Annuities: You bear the investment risk, which can lead to higher or lower income over time.
  Example: Similar to having a stock portfolio; if the market performs well, your portfolio grows. If it performs poorly, your portfolio and income shrink.

3. Flexibility

• Life Annuities: No flexibility in changing income once set; no access to the initial lump sum.
  Example: Like signing a long-term lease on an apartment where you can’t change the terms once you move in.
• Living Annuities: High flexibility in income drawdown and investment choices; access to remaining capital.
  Example: Owning your home, where you can decide how much to spend on renovations and whether to rent out a room for extra income.

4. Longevity Risk

• Life Annuities: Protect against outliving your savings, as income continues for life.
  Example: It’s like having a lifetime membership to a club; no matter how long you live, you always have access.
• Living Annuities: Risk of depleting your savings if you live longer than expected and/or if investments underperform.
  Example: Imagine having a savings account that you withdraw from regularly; if you withdraw too much or live longer than expected, the money might run out.

5. Estate Planning

• Life Annuities: Typically, no residual value for heirs upon your death, unless a guaranteed period was chosen. If you pass away after the guaranteed period, the remaining funds are forfeited.
  Example: Similar to renting a property where, after you pass away, your lease ends and there’s nothing left for your family, unless there’s a clause that provides benefits to your family for a certain period after your death.
• Living Annuities: Any remaining capital can be passed on to your beneficiaries.
  Example: Like owning property; if you pass away, the ownership can be transferred to your heirs.

Practical Examples

Life Annuities Example

Imagine John, a 65-year-old retiree. He has R1,000,000 in retirement savings. He decides to buy a life annuity. The insurance company calculates that they can pay him R8,000 per month for the rest of his life. John likes the certainty and the peace of mind that he will never run out of money, no matter how long he lives. He doesn’t have to worry about how the stock market performs or managing investments.

John also chooses a guaranteed period of 10 years. This means if John passes away within 10 years, his beneficiaries will continue to receive the payments until the end of the 10-year period. However, if John lives beyond the 10 years, he continues to receive payments for life, but no further payments are made to his beneficiaries after his death.

Living Annuities Example

Now, consider Mary, also 65 and with R1,000,000 in retirement savings. She chooses a living annuity because she wants to have control over her investments. Mary enjoys following the stock market and believes she can manage her funds to achieve better growth. She decides to withdraw 5% of her savings per year, giving her R50,000 annually, or about R4,167 per month. Mary understands that if her investments do well, her income could increase. However, she’s also aware that if the markets perform poorly, she might need to reduce her withdrawals to avoid running out of money.

Mary also likes the idea that any remaining capital in her living annuity can be passed on to her children when she passes away. This provides her with peace of mind that she can leave a financial legacy for her family.

Which One Should You Choose?

The decision between a life annuity and a living annuity depends on your personal circumstances, risk tolerance, and financial goals.

• Life Annuity: Ideal if you want a guaranteed, stable income for life and prefer not to worry about investment risks.
  Example: Suitable for someone like John, who values certainty and doesn’t want to manage investments.
• Living Annuity: Suitable if you want more control over your investments and income, are comfortable with investment risks, and wish to leave a legacy for your heirs.
  Example: Perfect for someone like Mary, who enjoys managing investments and is comfortable with the associated risks.

Factors to Consider

1. Health and Longevity: If you have a family history of longevity, a life annuity might provide better value as it ensures a lifetime income.
2. Financial Literacy: If you’re knowledgeable about investments and market trends, a living annuity might suit you better.
3. Income Needs: Consider how much income you need and whether you prefer a fixed amount (life annuity) or are comfortable with a variable income (living annuity).
4. Inflation: Think about how inflation might affect your purchasing power. Life annuities with inflation protection can help, but they start with a lower initial payout.
5. Estate Planning: If leaving money to your heirs is important, a living annuity allows you to pass on any remaining capital.

Conclusion

Choosing between a life annuity and a living annuity is a significant decision in retirement planning. Understanding their differences can help you make an informed choice that aligns with your financial needs and goals. If you need personalized advice, consider giving us a call to explore which option best suits your situation. Remember, what works best for one person might not be suitable for another, so it’s essential to consider your unique circumstances and preferences.