A living annuity can be an effective and flexible vehicle for generating income in retirement, but it is not without its risks. Unlike a life annuity, where the insurer assumes the investment and longevity risk, a living annuity places the responsibility for preserving and managing your capital firmly on your shoulders.
This means that the decisions you make regarding withdrawals, investment strategy, and ongoing management will have a direct impact on whether your money lasts as long as you do. Unfortunately, many investors enter into living annuities without fully appreciating the implications of their choices, and the mistakes they make can have long-lasting consequences.
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The drawdown dilemma
One of the most common mistakes is setting the drawdown rate too high from the outset. Legislation allows you to withdraw between 2.5% and 17.5% of your capital each year, but while the upper limit may seem tempting – especially in the first few years of retirement – drawing too much too soon can decimate your capital.
For example, if you start with R4 million and draw 10% per year, your income before tax would be R400 000. Unless your portfolio consistently achieves double-digit returns after fees and inflation, your capital will steadily decline, making recovery increasingly difficult. The damage caused by high drawdowns early in retirement is often irreversible, especially when combined with poor market performance. A more cautious withdrawal rate, ideally guided by cash flow modelling, gives your capital the breathing space it needs to grow and withstand market fluctuations.
Risk and volatility
Another mistake is failing to appreciate the impact of investment risk and volatility on the sustainability of your income. Because a living annuity is an investment, your capital is exposed to market movements, and this exposure needs to be managed carefully.
Some retirees become overly conservative, shifting too much into cash or fixed income, which can result in returns that do not keep pace with inflation, thereby gradually eroding the purchasing power of their income.
Others take the opposite approach, investing too aggressively without the capacity to withstand short-term losses. For example, a severe market downturn in the early years of retirement can be particularly damaging if you are withdrawing a steady income at the same time. The key, therefore, is to find a balanced investment strategy that provides growth potential to combat inflation while maintaining enough stability to preserve capital during market volatility.
Hidden cost of fees
Every rand paid in administration costs, fund management charges, and advisor fees reduces the amount available to grow and sustain your capital – and ignoring fees is another common pitfall that retirees need to look out for. This is because over a retirement period of 20 or 30 years, even small percentage differences in fees can add up to substantial sums.
Many investors fail to request the effective annual cost of their living annuity, which consolidates all charges into a single percentage figure, making it easier to compare platforms and products. Without this clarity, it is easy to underestimate the detrimental effect that fees can have on your investment.
Lack of diversification
In our experience, a lack of adequate diversification is another common mistake that retirees make. Remember, concentrating too heavily in a single asset class, geographic region, or fund manager can leave your annuity vulnerable to specific risks.
For example, placing all your capital in South African equities may expose you to the volatility of a single market and currency, while placing it entirely in offshore assets can introduce unnecessary currency risk. Diversification across asset classes, sectors, and regions is a fundamental way to manage risk and smooth returns over time, yet it is often overlooked in favour of chasing recent top performers.
Regular reviews
Many investors also neglect to review their living annuity regularly, keeping in mind that retirement is not static. Market movements, inflation changes, personal expenses adjust, and your health status may change.
Without regular reviews, withdrawal rates that were sustainable five years ago may no longer be appropriate to your changed set of circumstances. As such, we believe that an annual review of both your drawdown rate and asset allocation is essential to ensure your plan remains aligned with your goals and current market realities.
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Beneficiary nominations
Another area of oversight is failing to keep beneficiary nominations up to date. One of the advantages of a living annuity is that, in the event of your death, the proceeds can be paid directly to your nominated beneficiaries, thereby bypassing the deceased estate and avoiding estate duty and executor’s fees.
However, if your nominations are not kept current, the proceeds may be distributed in a manner contrary to your intentions or cause delays in the estate administration process. In our experience, life events such as marriage, divorce, the birth of children, or the death of any named beneficiaries should prompt a review of your beneficiary arrangements.
Emergency fund
Failing to maintain an adequate emergency fund in retirement is a common pitfall among retirees. Bear in mind that living annuities do not allow lump sum withdrawals outside of the annual income (except where the residual capital is lower than R125 000), and any unexpected expenses may force you to either increase your drawdown – thereby accelerating capital depletion – or liquidate investments at an inopportune time.
As such, maintaining an accessible pool of discretionary savings outside the annuity is essential to avoid disrupting your long-term retirement plan.
Tax planning
Not understanding your tax position can also result in costly mistakes. While investment growth within a living annuity is tax-free, the income you draw is taxable at your marginal rate. This means that large drawdowns can push you into a higher tax bracket, resulting in more tax being paid than necessary.
In some cases, structuring your withdrawals to keep your taxable income within a lower bracket can significantly improve the after-tax sustainability of your income. Additionally, if you have multiple income sources in retirement, it is important to manage pay-as-you-earn deductions to avoid an unpleasant surprise at the end of the financial year.
A ‘set and forget’ approach
A final – and perhaps overarching – mistake is treating the purchase of a living annuity as a once-off decision rather than an ongoing process. While the initial choice of provider and portfolio is important, it is the ongoing management of withdrawals, investment allocation, costs, and tax planning that determines the long-term success of the annuity.
Retirees who adopt a ‘set and forget’ approach may find that their strategy drifts off course, leaving them exposed to risks that could have been mitigated with timely and informed adjustments.
A living annuity offers flexibility, control, and the growth potential – but in return, it requires active stewardship. In our experience, the most successful living annuity investors are those who approach the process with a long-term mindset, regularly review their plans, and remain disciplined in their decision-making.
