This article was first published in the 1st quarter 2018 edition of Personal Finance magazine.

When you retire as a member of a pension fund, two-thirds of your savings must be used to buy a compulsory annuity that provides you with an income. You can choose between a living annuity and a life annuity. A life annuity is an insurance-based product that provides a guaranteed income for life. A living annuity is a unit trust-linked investment that provides an income based on the capital and returns of the portfolio.

There are pros and cons to both, but let’s look at a few benefits of living annuities:

1. You can preserve wealth for your heirs
With a living annuity, the remaining capital value of the fund does not cease on your death, as is the case with life annuities; it passes to your nominated beneficiaries.

2. You have a say in the asset allocation
You can choose the asset allocation of the investments, which means you can structure the portfolio according to your risk profile and time in retirement. Intelligent asset allocation should balance risk (the volatility of the assets) against the potential returns of the assets.

3. You select the drawdown rate
You can set your income at anywhere between 2.5 percent and 17.5 percent of the annual value of the fund, depending on the performance of the underlying investments and on your circumstances. You can change this percentage once a year, on the anniversary of the inception date. As a general rule of thumb, if you want to preserve the value of your capital, you need to draw down less than four percent of its value annually.

4. You can nominate any beneficiary
Unlike other retirement products, the beneficiary of your living annuity does not have to be financially dependent on you. With your pension fund, for example, If you nominate a financially independent beneficiary, the trustees of the fund may not adhere to your nomination if your children are still financially dependent on you. In the case of living annuities, the transfer of funds on your death will follow your nomination – regardless of financial dependence. You can even nominate a trust as a beneficiary. As the trust cannot own the fund, the proceeds are usually paid to the trust as a lump sum.

5. You can minimise estate duty
In South Africa, retirement funds, including living annuities, do not form part of your deceased estate. On your death, the capital is transferred directly to your beneficiaries without attracting estate duty or executor’s fees. However, if you have not nominated beneficiaries, the proceeds will form part of your estate. In such a case, the executor may charge a fee, but the amount will not attract estate duty. Another advantage is that your beneficiaries benefit immediately, without having to wait until the estate has been wound up.

6. Your beneficiaries can choose what to do with the funds
Your beneficiaries have almost immediate rights to the capital value and income from the fund. Beneficiaries are only required to provide three things to allow the transfer of the funds: the fundholder’s death certificate and the beneficiary’s proof of identity and residence.Your beneficiaries can:
•  Withdraw the amount as a lump sum on your death;
•  Maintain the annuity in their name/s, changing the drawdown rate and asset allocation to suit their investment objectives and circumstances; or
•  Make a partial withdrawal and transfer the balance as a living annuity in their name/s.

Note that when your beneficiary withdraws the funds, he or she should beware of the tax man. The withdrawal will be regarded as a lump-sum withdrawal and the appropriate rates at retirement will apply. Your beneficiary will receive the money only after tax has been paid.

With choice comes responsibility
Living annuities give you more choice than life annuities, but they also carry more risk. The onus is on you and (your financial adviser) to ensure that your income lasts for the duration of your retirement.

Living annuities allow you to pass on a legacy, but it is vital to educate your beneficiaries about their choices.