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Living Annuitants 

Dear Living Annuitant/ prospective Living Annuitant,


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A living annuity (as opposed to a life annuity) can be (but is not always) an appropriate form of pension.  As with any financial instrument it carries both risks and opportunities.  If you are considering using a living annuity to provide you with a pension at retirement

  • take advice, and make sure this is right for you before you decide.

 If you have decided to use a living annuity to provide you with a pension at retirement

  • consider the advantages of a UCTRF living annuity before you decide.

 This leaflet gives you some pointers about living annuities (LA’s, or often referred to as Investment Linked Living Annuities or ILLA’s) 

What is a living  annuity?

A Living Annuity (LA) is an annuity or (pension payment) that should “live” for the rest of your life time. Your retirement capital is used to set up an account from which annuity or pension payments (drawdowns) are made, fees are deducted and investment returns added.

As a Living Annuitant, your responsibility increases in that you assume mortality risk over and above the investment risk that you have carried up to now. As your capital must last for your lifetime, you need to be very aware when you start “eating” into capital, in other words when your annuity (draw down) amount is more than the investment returns on your capital. This could result in your not having enough money to last you the rest of your life. You should also be very aware of which Portfolio you choose to invest in - if you are, for example, fully invested in a market -linked portfolio and the markets crash, it will have a detrimental effect on your annuity as well as on the term it will be payable. This forms part of the investment risk you carry.

Legislated minimum and maximum annual drawdown amounts are set by law. The current legislated minimum and maximum drawdown amounts are set at 2.5% and 17.5%, respectively, of the capital balance of the living annuity account at the anniversary date.

Who should choose a living annuity?

Advantages of living annuities:

Flexible drawings

You can select the annual rate of drawings. This facility can greatly assist in minimising tax paid on pension. If you are in poor health and/or suffer from a terminal disease, you can draw higher amounts for medical care. This is one time that you could consider drawing more than 5% of your capital every year.

An ILLA might be suitable for a retiree who expects to continue earning for, say, 5 years after retirement and thus “park” his retirement capital for 5 years and buy a life annuity 5 years later (taking advantage of the fact that rates for a 70 year old are very different from rates for a 65 year old, other things – especially interest rates – being equal)

Investment flexibility

You will have a range of investment portfolios to choose from if you are in the UCTRF (and with most ILLA products). You can also switch investments in order to obtain improved investment returns. Investing a portion of your funds in asset classes such as equities, could improve the probability of beating inflation over the medium to long term.

Capital protection/ legacy

Your remaining capital is not lost in the event of death after retirement, and is paid out to your dependants or nominees (if in a retirement fund) or to your nominees (with other ILLA’s). This is a particularly attractive feature for retirees suffering from poor health.

Conventional annuities seem less attractive as they offer a predetermined pension, no investment choice and the possibility of loss of capital upon death.

So why would any retiree not choose a living annuity given all these advantages?

Living annuities hold a host of dangers for very many retirees, and are probably not suitable investments for the average man (or woman) in the street.

What risks are associated with Living Annuities?

Risks associated with Living Annuities (disadvantages)

As a living annuitant, there are four important risks, namely:

• Investment risk
• Inflation risk
• The risk of living too long!
• Drawing risk

Investment risk
Investment risk refers to the chance that the investment returns you earn on the money you invest at your retirement are insufficient to provide a reasonable income throughout your retirement.

The investment risk depends on the asset class in which you invest your money, investment performance and on how long you can invest the money before you need to use it (i.e. your investment horizon).

Inflation risk
One of the big risks you face in retirement is that inflation reduces the buying power of your pension.
It is very difficult to predict the future course of inflation (i.e. it may go much lower or maybe it could increase sharply). It is therefore important that you invest your retirement money, or at least that part which covers your basic needs, in such a way that your income goes up each year more or less in line with inflation.

Risk of living too long (mortality risk)
This seems like an unusual risk - but the longer you and your dependants live, the more money you will need after retirement.

Many people have a pessimistic view of how much longer they will live once they retire. The following table shows, how long, on average a male and female are expected to live if they retire at different ages.

Retirement age

Life expectancy

Male

Female

55

22 years

27 years

60

18 years

22 years

65

14 years

18 years


The above figures may well understate the position, because life expectancy of people is increasing and living into one’s 90’s is now common.

No mortality insurance is provided by living annuities as with conventional/ life annuities. Retirees who purchase life annuities are effectively insuring against the risk of living too long.

ILLA’s may seem attractive in the early years following retirement, but there is a high probability that these annuities will not be delivering an adequate pension as early as 10 years after retirement. If you live 20 to 30 years after retirement you might find yourself facing a continually dropping standard of living because living annuities are designed so as to pay out all that remaining capital to the dependants of pensioners who die in the early years following retirement rather than retaining the remaining capital for those pensioners who live longer than anticipated by the actuaries.

Drawing risk
The annuitant assumes the responsibility for choosing the amount of drawings each year. The temptation may exist to draw a too high percentage. A high drawing will very quickly erode the capital base, and will result in an inadequate pension within the space of a few years. As a rough rule of thumb an annual drawing rate above 6% will probably result in great hardship in later years.

By example:

If we look at the living annuity in practice you will see that if your return on investment is less than the chosen draw down, your capital will begin to be depleted.

Let’s look at a pensioner with R1 000 000 retirement savings. The table below shows what happens to the pensioner’s income if he wants to increase his income by inflation each year. The reality is that starting off with a 7% drawdown is too high and will result in income decreasing if the pensioner survives 10 years as the pensioner is not allowed to draw more than 17.5% of their lump sum. Considering that the average life expectancy for a 65 year old is 20 years, this points to an unacceptable situation.

Age

Lump sum

Income Draw

Income per annum

Income per month

65

R1 000 000

7.0%

R70 000

R5833.33

66

R995 100

7.5%

R74 200

R6183.33

67

R985 363

8.0%

R78 652

R6554.33

68

R970 181

8.6%

R83 371

R6947.58

69

R948 886

9.3%

R88 373

R7364.42

70

R920 749

10.2%

R93 676

R7806.33

71

R884 968

11.2%

R99 296

R8274.67

72

R840 669

12.5%

R105 254

R8793.67

73

R786 894

14.2%

R111 569

R9297.42

74

R722 597

16.4%

R118 264

R9855.33

75

R646 637

17.5%

R113 161

R9430.08

76

R570 819

17.5%

R99 893

R8324.42

77

R503 890

17.5%

R88 181

R7348.42

78

R444 809

17.5%

R77 842

R6486.83

79

R392 655

17.5%

R68 715

R5726.25

80

R346 616

17.5%

R60 658

R5054.83

Realistically the maximum drawdown that should be taken on a living annuity is 4% which translates to a monthly income of R3 333 per R1 million rand. The living annuity is therefore typically suitable for the domain of the wealthy individual who has overfunded for his/her retirement.

CAPITAL PROTECTION SHOULD BE A SECONDARY CONSIDERATION – FIRST MAXIMISE YOUR INCOME FOR LIFE!!!!

Living annuities are very flexible products and offer many attractions to the sophisticated investor. They do, however, have some significant disadvantages, and as such are probably not suitable for the vast majority of South African retired persons, therefore, if you choose a Living Annuity you are confident that you:

  • Have the relevant financial knowledge to make the correct decisions in choosing your Portfolio’s or have taken advice from a financial advisor
  • Can accept the risk of living longer than the average male/female, rather than insuring that risk with an Insurer, i.e. purchasing a Life Annuity
  • Have sufficient assets to support you in the event of continued bearish markets which may deplete your assets in your Living Annuity Account
  • Your spouse will have the necessary knowledge to choose between the different options should you predecease him/her and he/she is financially dependent on you.
Managing a Living Annuity from the UCTRF

As a member or deferred pensioner or other beneficiary of the UCTRF, you may purchase a living annuity from the UCTRF, becoming entitled to a pension.

Drawdown percentage

A drawdown is the percentage of annual income which a Living Annuitant chooses to receive for the year. You must elect your annuity/pension level annually. The pension can be paid to you monthly, quarterly, biannually or annually. This must be a percentage of your living annuity balance at the time of election. This percentage may not be:

  • less than the minimum percentage as prescribed by the Commissioner (see above);
  • more than the lesser of the maximum percentage prescribed by the Commissioner and the maximum percentage prescribed annually by the Trustees on the advice of the Actuary.

The UCTRF's administrator will send your Annual Income Change form to you for completion within two to three months of your annuity anniversary date. Please complete and return this form to the Administrator by the due date to ensure the continuous payment of your pension.

Please note that the Rules provide the Trustees with the power to enforce maximum prudent percentage draw-downs, as calculated by the Actuary, in order to protect the capital invested in living annuities by Pensioners. It is advisable that you speak to a financial advisor to help you decide on your draw-down percentage.

Rule 5.5(1) LIVING ANNUITY paid from the FUND

(a) the LIVING ANNUITANT must elect, prior to the EFFECTIVE DATE, his/her draw down rate equal to a percentage of his/her LIVING ANNUITY BALANCE ACCOUNT as at the EFFECTIVE DATE. Thereafter the LIVING ANNUITANT must, prior to each subsequent anniversary of the EFFEECTIVE DATE, elect his/her draw down rate equal to a percentage of his/her LIVING ANNUITY BALANCE ACCOUNT as at the anniversary of the relevant EFFECTIVE DATE, which percentage may not be:

(i) less than the minimum or more than the maximum percentage prescribed by the REVENUE AUTHORITIES in this regard; or

(ii) more than the lesser of the maximum percentage prescribed by the REVENUE AUTHORITIES and the maximum percentage prescribed annually by the BOARD on the advice of the ACTUARY in this regard, provided that a LIVING ANNUITANT may, subject to certain conditions laid down by the BOARD from time to time, elect a percentage higher than the maximum prescribed by the BOARD, understanding that, where the LIVING ANNUITY BALANCE falls below the amount prescribed by the REVENUE AUTHORITIES, the LIVING ANNUITANT may commute for a lump sum payment his/her full LIVING ANNUITY BALANCE.

Choosing the appropriate drawdown

When a Living Annuity is purchased and at least once a year thereafter, the UCTRF must provide you with written guidance as to whether your withdrawal rate places your future pension at risk.

Apart from explaining both the advantages and the risks of a Living Annuity, a financial adviser must explain and compare these advantages and risks against conventional annuities, where a longterm insurer carries the full investment risk and the risk of the annuitant living longer than expected.

The UCTRF must inform living annuitants that:

  • A living annuity allows you to set your income level within the official drawdown limits (currently between 2.5% and 17.5%) and allows you to select a range of investments in respect of the capital that will generate the annuity.
  • Neither the percentage nor the Rand income level selected is guaranteed for life. The level of income may be too high and may not be sustainable if:

1) You live longer than originally expected; or

2) The return on the capital is lower than that required to provide a sustainable income for life.

Maximum withdrawal rates

The following table issued by the Association of Savings and Investments South Africa (ASISA) can be used as a guideline in determining your maximum withdrawal rates:

AGE

55

60

65

70

75

80

85

Male

5.4%

6.2%

7.2%

8.5%

10.3%

12.8%

16.3%

Female

4.7%

5.3%

6.1%

7.2%

8.7%

10.9%

14.1%

  • It is your responsibility (in consultation with the financial adviser) to ensure that the income level selected is at a level that will be sustainable for a lifetime. The income drawdown relative to the investment return on the capital to achieve this, needs to be carefully managed.
  • Drawdown percentages depend on each individual ‘s circumstances.

The table below, which shows the number of years before the income will start to reduce, can be used as a guide.

Years before your income will start to reduce:

NET INVESTMENT RETURN

(before inflation & after all fees)

ANNUAL DRAWDOWN

PERCENTAGE

2.5%

5%

7.5%

10%

2.5%

21

30

>50

>50

5%

11

14

19

33

7.5%

6

8

10

13

10%

4

5

6

7

12.5%

2

3

3

4

15%

1

1

2

2

17.5%

1

1

1

1

The table assumes that the drawdown percentage income selected will be adjusted over time to maintain roughly the same amount of real income after inflation (in this case using a rate of 6.0% per annum.)

Once the number of years in the table has been reached, the income will start to diminish rapidly in subsequent years.

Thus, for example:

  1. if you elect a drawdown rate of 5.0% per annum and the UCTRF earns an average 7.5% per annum on the underlying investment, you can expect to be able to maintain a real level of income (after inflation) for some 19 years but thereafter you will have to accept a reduced real income level.
  2. if you buy into the living annuity at age 70, you may face a problem if you live beyond age 89, so perhaps, to err on the side of caution, the drawdown level should be reduced to 4.5% initially.
  3. if you buy into the annuity at age 60, a drawdown level of 3.5% to 4.0% would be realistic, since 2.5% would result in the income level being maintained for over 50 years but a drawdown of 5.0% would only support the income for an expected 19 years.
    • It is always better to start on the lowest possible drawdown level that the you can afford, since this will allow for less chance of the capital being eroded quickly, more growth and the likelihood of being able to afford higher drawdown levels later, when you may need more (e.g. for medical costs).
    • When using the table, the full financial situation should be taken into account, with all sources of income. It is an indicative guideline to assist in making informed decisions about a living annuity only.
    • Living Annuitants may transfer an ILLA investment from one product provider to another, subject to the terms of the Long Term Insurance Act (or the Pension Funds Act if provided directly by the retirement fund).
    • An ILLA may be converted to a conventional guaranteed life annuity administered by an insurer. This is a “once-off’ option that cannot be reversed, but is useful in specific cases.

!! It is advisable that you speak to a financial advisor to help you decide on this percentage!!

Further reading: See the attached articles from personal finance at the bottom of the page.

Investment Choice

Living Annuity investment portfolio options

As a Living Annuitant you have exactly the same Portfolio options to choose from as you had as an active member/ deferred pensioner of the UCTRF, i.e. Portfolio A, B, C and D.

How do I choose an investment portfolio?

Living Annuitants have different needs and requirements when it comes to investments and the risks they, as pensioners, can accommodate. Each Portfolio in the UCTRF has its own unique risk profile and you choose the portfolio that is most suitable for you and with a risk profile that closely matches your needs and expectations.

How important are historic returns when choosing an investment portfolio?

Portfolios invested in shares will usually have good returns in some years and poor returns in other years. But over a twenty-year period, their chance of achieving good returns is high. It is therefore not a good idea to look at short-term historic returns when deciding on which portfolio to choose. Typically, members switch out of poor performing portfolios when markets fall and are not there to reap the good returns when these portfolios eventually recover.

When may I switch?

Living Annuitants may switch between portfolios on 31 March and 30 September of every year.

 

Exits from a  Living Annuity

Can I transfer my Living Annuity with the UCTRF to another insurer?

You may use the balance in your Living Annuity Account to purchase either a Living Annuity or a Life Annuity from another Insurer.

Can I withdraw the capital from my Living Annuity?

If the living annuity balance falls below the amount prescribed by the Commissioner, at that time, the pensioner or beneficiary as the case may be, may commute the amount and be paid this in cash.

What happens to my living annuity in the event of my death?

When selecting a living annuity, and at any time thereafter, you can nominate a beneficiary or beneficiaries to inherit your capital balance in your living annuity account.

The remaining capital can continue to be paid to your beneficiary or beneficiaries as it was paid to you, or it can be taken as any other pension that may be purchased, or your beneficiaries can elect to take a lump sum payment. The allocation is determined by the Trustees in terms of Section 37C of the Pension Funds Act 24 of 1956.

Section 37C of the Pension Fund Act and the rules of the UCTRF state that in the event of your death, your benefit in the UCTRF should be distributed as follows:

  • To financial dependants; or
  • Financial dependants and nominees; or
  • If there are no financial dependants, to nominees (but any deficit in your estate first has to be settled); or
  • If there are no dependants or nominees, to your estate.
  • Although the Trustees will follow members’ wishes in terms of their nomination of beneficiary form as far as possible, the final decision of who will receive the UCTRF death benefits rests with the Trustees, who must abide by the Rules of the UCTRF as well as Section 37C of the Pension Funds Act.
Costs associated with Living Annuities

Fees and costs associated with taking a living annuity from the UCTRF:

  • There is a once-off set-up fee charged by the UCTRF when a new Living Annuity pension commences. This is currently R508 including VAT, and will be deducted from the retiring member’s accumulated credit at the time that the Living Annuity is set up.
  • Monthly amounts are deducted from the pensioner’s Living Annuity account to cover the expenses of maintaining the account and making income payments to the pensioner. Currently these charges are R71 per month including VAT for administration, and R12.76 for annuity payments. These charges will be reviewed by the Trustees from time to time, and will be increased as the cost of providing the service increases. The admin fee will increase to R112 in March 2018.
  • A switch fee of R491 including VAT will charged for investment switches on 30 September each year. This fee will be deducted from the pensioner’s Living Annuity account. Switches on 31 March currently incur no fee.
    The pensioner will pay investment management fees on the same basis as in-service members of the UCTRF. These are currently as follows:
    • Portfolio A (Income Fund) – the investment fee is 0.10% p.a. plus VAT.
    • Portfolio B (Smoothed Bonus Fund) – management fees of 0.50% p.a. are deducted from the gross bonuses declared each month by the insurance company (Momentum Life) to cover the cost of investment management. In addition, a capital charge of 1% p.a. is deducted from the value of the underlying assets before bonuses are declared, to cover the cost of the guaranteed provided by Momentum as well as the cost of product administration.
    • Portfolio C (Balanced Fund) – the assets underlying Portfolio C are invested with a number of different UCTRF managers, so the total investment management fee is a weighted average of the amounts paid to each manager, and will vary from time to time as the mix of managers changes. In a few cases the manager may at times receive performance fees for good investment performance, which will also cause the total fees to vary over time. The base fees are currently estimated to be some 0.47% p.a. plus VAT, and it is likely that the total fees will average some 0.70% p.a. plus VAT over the longer term if performance fees are also included.
    • Portfolio D (Shari’ah Fund) – this is invested in a multi-manager portfolio, for which there is a fee of 0.30% p.a. for product management and administration, plus fees paid to the underlying investment managers. However, the total, combined fees will not exceed 0.90% p.a. plus VAT.
  • You may need to seek financial advice before making an investment decision.


Living annuities from Insurers are generally more costly than from UCTRF, as shown in the following comparison (table based on a capital amount of R1 million). The Insurer charges are indicative of the level of charges levied by Insurers:

Cost item

Indicative Insurers cost

UCTRF

Cost basis

Cost basis

Annuity payment fee

1% of assets – may be on a sliding scale.  This fee may be subsidized from the investment fees (i.e. you may not pay it directly)

R508 initial management fee

R12.76 per payment

Annuity administration fee

0.75% first R250k
0.5% next R500k
0.25% above R750k 

R71 per month

Investment fees

0.5% to 1.5% p.a. of market value of assets (depends on portfolio chosen by member)

0.2%  to 0.9% p.a. of market value of assets (depends on portfolio chosen by member)

Switching fees

Insurers now commonly allow free switching

R491 per switch

Advisor's fees

Negotiable up to 1% p.a., but insurers may also accept “direct clients” where no advisor is involved

Not applicable

First-year comparison based on R1m

R15 000

R1 184


 

 

Living Annuities in summary
  • A Living Annuity is different from a life annuity (pension). It is not guaranteed for life, so your money can run out.
  • You invest a cash lump sum with the UCTRF, an investment house with a Life License or an Insurer and then withdraw a monthly pension from that amount. The bigger your capital (amount invested) and the higher your investment returns, the more you will be able to withdraw. The smaller your invested capital, the less you will be able to withdraw.
  • You will receive a monthly pension for as long as there is money available in the UCTRF.
  • You can select to withdraw between 2,5% and 17,5% of the remaining capital. Please note that the UCTRF has a discretion to limit your withdrawal (see UCTRF Rules).
  • You will have a range of investment portfolios to choose from if you are in the UCTRF (and with most ILLA products).
  • The remaining capital in the event of death after retirement, is paid out to dependants or nominees (if in a retirement fund) or to nominees (with other ILLAs).
  • Payments are not guaranteed for life as you can run out of money before you die.
  • This is usually not a viable option for a member with a relatively small lump sum at retirement, and no other significant assets to support him/her for the remainder of his/her life.
Life Annuities vs Living Annuities

An ILLA, for example, might be suitable for a retiree who expects to continue earning for, say, 5 years after retirement and thus “park” his retirement capital for 5 years and buy a life annuity 5 years later (taking advantage of the fact that rates for a 70 year old are very different from rates for a 65 year old, other things – especially interest rates – being equal).

The right questions you should ask:

  • How much income do you want in retirement?
  • How much income do you need in retirement?
  • How much can you afford with my retirement savings?
  • Do you have other sources of income?
  • Do you have the relevant financial knowledge to make the correct decisions in choosing your Portfolio’s
  • What will happen to the pension income over time taking into account the future inflation? Or put simply, how much would you be able to afford to buy with your pension 20 years from now?
  • Can you sacrifice a portion of the income now, to enjoy relatively higher income later in retirement?
  • What impact will different investment strategies have on you pension in the future?
  • What is the risk of outliving your retirement savings?

 

Receive a guaranteed income for the rest of your life (life annuity)

If you choose the life annuity, you will be provided with a guaranteed income throughout your retirement years as long as you are alive. You will receive the annuity income after the deduction of any required tax throughout your lifetime. On death, the annuity income will end.

The life annuity provides the following options at the start of your policy (note, these cannot be changed after the start of your policy):

  • Annuity income increase rate: You can choose at what level to have your income increase at each policy anniversary.
  • Guarantee term: You can choose to have your income payable for a guaranteed period. This ensures that on death before the end of the guarantee term, your annuity income will continue until the end of the guarantee term. The income will be payable to your chosen beneficiaries.
  • Joint annuity: You can choose to have your income payable for as long as you or your spouse is alive. You may also choose to have your income decrease to a certain level after the first death for the remainder of the life of the surviving spouse.

OR

 

Manage your own investment and leave a legacy (living annuity / ILLA)

A living annuity allows you to manage your investment. Your investment will be invested in your choice of funds and the income you receive will be determined by the amount you choose to withdraw out of your living annuity account. According to current legislation (March 2012), you may choose to withdraw between 2.5% and 17.5% of your investment fund each year.

You may change the amount of income which is paid each year in accordance with legislated limits. You also have the option to transfer the remaining funds in your living annuity a life annuity; however, a life annuity cannot be transferred.

This option will suit your needs if you want to manage your investment and have the flexibility to change your income from time to time. Under this structure it will be your responsibility to ensure that your investment is enough to sustain your income throughout your retirement years. On death, any remaining funds will be paid to your beneficiaries.

You need your savings to continue to sustain the income you need for a comfortable retirement once you’re retired. That’s why it’s important to choose an investment strategy that minimises the likelihood of a shortage in income during retirement. The best solution may not be the one that gives you what you want right away.

Here’s an example of a man retiring with R1 000 000 in fund savings. The table below shows the initial monthly income you could expect to get from different types of annuities (pensions):

Type of pension

Initial monthly pension

Value of pension in 10 years’ time, after inflation*

Value of pension in 20 years’ time, after inflation*

Level annuity

7 160

4294

2576

Fixed increase annuity (at a fixed rate of 5% per year)

4 333

4235

4127

With-profit annuity

4960

4700

4404

Inflation-linked annuity

4110

4110

4110

Living annuity
(at 7% income draw down rate)

5733

4173

3038

*Figures are based on certain actuarial assumptions

* Key observations:

  • Level annuity is unlikely to meet your income needs and wants.
  • Fixed increases annuity has a good chance of meeting your income needs.
  • With-pofit annuity has a fair chance of meeting your income needs and a poor chance of meeting your income wants.
  • Inflation-linked annuity is certain to meet your income needs throughout retirement.
  • Living annuity has a fair chance of meeting both your income needs and wants in retirement
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