Clearing up the confusion about annuity products
There are essentially three “annuity” products on the market, of which one contains the word “living” and another the word “life”. That in itself is confusing. Living and life annuities are post-retirement products that use the term “annuity” in its strict sense of something that provides regular income payments - in other words, a pension.
The third “annuity” on the market is not a pension product at all, but a pre-retirement savings vehicle.
1. Living annuity: An investment-linked living annuity (illa), to give it its full name, is a pension product that you “buy” with your retirement savings when you retire. It sits on an investment platform that offers a choice of underlying funds.
You have full control over both the underlying investments and your drawdown (the percentage of capital you draw annually as income, which can be paid to you in monthly instalments), within limits. You take on the investment risk and the risk of running out of capital before you run out of life.
Because you buy the product with the proceeds of a retirement fund (to which contributions are tax-deductible), you pay income tax on your income. Whatever capital is left over when you die goes to your beneficiaries.
2. Life annuity: So called because it is a pension product provided by a life insurance company, a life (or guaranteed) annuity is literally a life insurance policy in reverse: you give the insurer a lump sum (your retirement savings or a sum from discretionary savings) and the insurer pays you an income for the rest of your life. This may be a fixed rand amount, or it might be inflation-linked, and it may also cover your spouse. It gives you and your spouse the security of never having to worry about your income for the rest of your days. But a life annuity dies when you (or your spouse) dies - there’s nothing left over. If bought from retirement fund savings, you pay income tax on your pension.
3. Retirement annuity (RA): This is a pre-retirement product in which you accumulate savings. It’s basically your own personal retirement fund, and was designed primarily for the self-employed, but now used by many to supplement their retirement savings. It enjoys the same tax status as retirement funds, with your contributions being tax-deductible up to certain limits.
You cannot draw an income from an RA - at age 55 or at any later age you can take one-third of it as cash (on which there are tax implications), but the other two-thirds must be used to buy a pension in the form of a living or life annuity.
In none of these products are investment returns and capital gains taxed.
There are variants among the first two, including hybrid products, such as a with-profit annuity, which is essentially a life annuity that gives you increases related to the returns of its underlying investments, over which you may have a certain amount of choice.
Living to life
A living annuity can be converted to a life annuity, but not the other way around. Once you are in a life annuity you are literally in it for life.
Personal Finance put the following questions to Segabe Ditodi, head of legal and compliance at Just in South Africa, about converting your living annuity to a life annuity:
Can you outline the procedure involved in transferring from a living annuity to a life annuity with a different provider?
You or your adviser must notify the provider (Provider A) of your intention to transfer out of the living annuity. This is usually accompanied by a signed quote and application form from the life annuity provider (Provider B). Provider A drafts a set of annexures which is sent to Provider B, who in turn also drafts a set of annexures. Both sets of annexures must be signed by the client.
What transfer costs are involved?
None. Regulations stipulate that there can be no costs associated with transfer of a living annuity to a life annuity. Your adviser can charge a fee, but it should be invoiced separately and settled by you.
Can you convert a portion of the living annuity to a life annuity or must it be the entire amount?
No, you cannot transfer a portion of a living annuity to a conventional life annuity. However, if you transfer the full amount to a living annuity where a life annuity is available as a portfolio (often referred to as a blended living annuity offered by some product providers), you can allocate a portion of retirement assets to the lifetime income portfolio in tranches at any time.
How long does it take?
The timing of the process varies between providers and depends on factors such as delays in tax directives or the signing of annexures. The best-case scenario is two to four weeks, but it can take about eight weeks.
If the provider with which you have the living annuity also offers a life annuity, is the process easier?
Not necessarily. The process still needs to follow the same steps.