Living and Life Annuities:
Before delving into the specifics, it’s essential to understand what an annuity is. In simple terms, an annuity is a financial product that provides a regular retirement income.
The Essence of a Life Annuity
A life annuity is fundamentally an insurance policy. Under this contract, the insurer promises to pay a pre-agreed, guaranteed income for the remainder of the annuitant’s life.
The risk associated with market fluctuations and longevity is transferred from the individual to the insurer. This guarantee of stable income throughout retirement is a significant advantage of a life annuity.
However, once an annuity income is selected, it cannot be changed, even if circumstances change. Also, a life annuity typically ceases upon the death of the policyholder, leaving no residual assets for heirs.
Types of Life Annuities
Life annuities come in several forms, catering to different needs and affordability levels. Broadly, they can be categorized into single life, joint life, and capital protection life annuities.
- Single-life Annuity
A single-life annuity ensures that payments will cease when the annuitant dies. The policy can include a guaranteed period, such as 10, 15, 20, or 25 years.
If the annuitant passes away within this period, their beneficiaries will receive the income until the period lapses.
- Joint-life Annuity
A joint-life annuity allows the inclusion of a second life insured. Upon the death of the first annuitant, the income is transferred to the second annuitant and continues until their death. On the passing of both annuitants, if there is no guarantee period,the annuity will cease.
- Capital Protection Life Annuity
This annuity provides a guaranteed income to the annuitant , with or without a guaranteed yearly increase. The annuity has a nil guarantee and is backed by a life policy. On the death of the annuitant, the initial capital amount is paid out to the beneficiaries as a tax-free payment.
Weighing the Pros and Cons of Life Annuities
While life annuities come with the advantage of a guaranteed income, they also have limitations. They lack flexibility as the annuity income, once set, cannot be altered. Even if the annuity is linked to inflation, there’s no assurance that it will keep pace with pensioner inflation, which is often driven by medical inflation. The annuitant also has no say in how the insurer invests the funds.
Living Annuity: An Alternative Option
A living annuity, unlike a life annuity, is an individual investment owned by the retiree, who retains full control of their investment. The annuitant decides how much to draw from their investment, between 2.5% and 17.5% of the investment value per year. The annuitant also assumes all investment risk, exposing their capital to market volatility.
At the annuitant’s death, any remaining capital in a living annuity is distributed to their nominated beneficiaries, making it an effective estate planning tool. The biggest risk is running out of capital due to unsustainable drawdown levels or poor investment performance.
Choosing the Right Annuity
The choice between a life annuity and a living annuity depends on several factors, including the individual’s risk tolerance, the need for a guaranteed income, and the desire for flexibility and control over investments. Some retirees opt for a combination of both types of annuities, using a life annuity to cover fixed monthly expenses and a living annuity for discretionary expenses.
Tax Implications of Annuities
Both life and living annuity owners are required to pay income tax on the income they receive from their policies. With flexible drawdown levels, living annuity owners have some leeway to manage their income tax levels.
In conclusion, the choice between a life annuity and a living annuity is a personal one, shaped by individual circumstances and preferences. Understanding the fundamental differences between these options is crucial in making an informed decision.
Ensure you take the time to consider all the pros and cons and consult with a Financial Adviser to help you make the correct decision, that suits your circumstances.
by Josh Raad
