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Retirement Planning
Thursday, October 1, 2009
Sowing seeds

Most investors who have money in pension and provident funds will at some point look to allocate the bulk of these funds to a living annuity. Fund managers Coronation released an article discussing some of the pertinent issues with which we at Seed Investments agree.

While the tax rates on the lump sum withdrawals from pension and provident funds have been simplified, the rates are punitive for levels above R600 000 at 27% and above R900 000 at 36%.
A maximum of one third of the pension fund can be commuted as a lump sum, but with the higher tax rates, many investors with provident funds will also be transferring the bulk of their funds to a living annuity.
“Coronation points out the danger of not taking enough risk in the portfolio when allocating the bulk of a living annuity to low risk money market funds and at the same time having a fairly high income drawdown,” says Ian de Lange of Seed Investments.
While money market has provided an investor with an annual return of 9,8% per annum since 2000, an investment of R1m eight years ago with a 7% annual income, would now have a real value of only R569 800.
Had the initial R70 000 been inflated just with inflation from 2000, this would now be the equivalent of R116 850 and would represent a 12% drawdown on the current value, which is not sustainable.
So while a 7% income or drawdown from the annuity may appear sustainable when compared to historical and even current interest rates, the problem comes in that the annual annuity needs to be escalated annually just to compensate for inflation and this starts to have a real negative impact on the underlying portfolio. A consistently high cash component is unlikely to provide the real return required for most retirees.

Some of the advantages of a living annuity

Says De Lange, the investor of the annuity has the full flexibility to create a portfolio with no section 28 restrictions. i.e. 100% of the portfolio can be allocated to local equities or even offshore for that matter.
An income must be drawndown at a rate of between 2,5% and 17,5% per annum. This is altered on an annual basis.
On death the balance of the annuity, unlike a compulsory annuity, will be transferred to a nominated beneficiary.
Unlike conventional or guaranteed annuities therefore, living annuities provide the investor with flexibility, choice and ownership retention.
The living annuity itself does not attract any taxable income on capital profits, interest or rental income etc, but rather the level of income drawdown in the investor’s hands.
“For this reason where an investor has a total portfolio composed of a portion allocated to a living annuity and a portion in discretionary assets, it is important to optimise the asset allocation. If you are in your position, discretionary investors should be skewed to growth assets and living annuity assets skewed to income generating assets.”
 

Copyright © Insurance Times and Investments® Vol:22.10 1st October, 2009
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