When to annuitise – that is the question

Whilst working, one of your biggest worries is whether you are saving enough for your retirement. When you retire you will be faced with different needs than those you faced before retirement. Your income stream will also differ from the income stream you had pre-retirement. Your medical expenses will be higher, you stop contributions into a pension fund, you have to pay off your mortgage and you still need to have some money to travel and buy monthly groceries. These needs will differ from one individual to the next.

At retirement, you firstly have to decide on the retirement vehicle which will best suit your needs. Your options include: a guaranteed annuity (level, increasing or inflation linked) or an investment-linked living annuity (ILLA) or a combination of these. A guaranteed annuity will provide you with regular (monthly, quarterly or annual) payments until you pass away, in exchange for a lump sum purchase. An ILLA enables you to transfer your retirement fund benefits into a personalised retirement portfolio that matches your risk profile and provides retirement income. You have to choose the income that you want from an ILLA subject to regulatory limits. You will continue receiving an income from your ILLA until you pass away or until you deplete the capital. You also have the option of annuitising part of, or your entire ILLA portfolio. Annuitising is when you use your accumulated investment to purchase a guaranteed annuity. However, deciding on when to annuitise can be very challenging. What is the optimal time to purchase an annuity? Is it age 60, 70 or 80?

There are many factors to this decision, including the following: the prevailing interest rates in the economy, the requirement to leave an inheritance for your dependants, the ability to meet emergency spending and the ability to beat inflation during retirement. However, retirees often do not consider the impact that mortality credits have on annuity payments. To explain the concept of mortality credits we will use the following example.

Consider a group of five 60 year old males who want to start an investment club. The rules of the club require each member to contribute R100 and the money will be invested in Retail bonds which yield 5% p.a. At the end of the year the accumulated investment will be shared among the survivors. Assume that the average probability of death for a 60 year old is 0.2. This means that on average four out of the five original investors will survive to reap the proceeds of their investment. They will share R525 (R500*(1.05)) giving each investor R131.25. The return that each investor makes is therefore 31.25% ({(131.25/100)-1}*100). Only 5% of this investment return comes from the returns generated in the market. A staggering 26.25% (31.25% - 5%) is due to mortality credits.

This shows the power of pooling which is used by most insurance companies. In our hypothetical example, what would happen if the money was invested in a portfolio of equities which experiences a drop in market value of 20%? Many would assume that the investment return will be negative. However, the total investment return will be 0% due to the mortality credits of 20%. This is the power of mortality credits which is experienced when purchasing annuities.

The investment club example is similar to the concept used in annuity pricing, albeit a broad generalisation of the annuitisation concept. It is therefore important to take account of mortality credits when deciding on the most appropriate time to annuitise. In Table 1 we show the increase in mortality credits for male and female annuitants as they delay annuitising. We use the South African annuitant standard mortality tables 1996-2000.

 The aim is to determine the point in time where the additional return from annuitising is sufficiently large enough to outweigh returns from other financial instruments available in the market. 

Mortality Credits (Percentages)
Age	Male	Female
50	0.70	0.29
55	1.09	0.45
60	1.72	0.70
65	2.64	1.13
70	3.78	1.79
75	5.45	2.93
80	8.47	5.10
85	14.04	9.31
90	23.60	16.82

BUDGET SUMMARY 2013

Budget 2013 - Tax Proposals

The budget was read on 27 February 2013 and the following tax proposals were made. Please note that this summary is limited to proposals impacting financial planning.

1. Personal Income Tax Relief

The tax tables will be amended to result in personal tax relief of R7 billion. The primary rebate is increased from R11 440 to R12 080, the secondary rebate from R6 390 to R6 750 and the tertiary rebate from R2 130 to R2 250. This results in the annual tax threshold being as follows:

- Under 65 years – R67 111

- Over 65 years – R104 611

- Over 75 years – R117 111

2. Exemptions

The interest exemption has been increased to R23 800 for natural persons under 65 and up to R34 500 for those older than 65.

3. Medical Tax Credits

At this stage all taxpayers over 65 may claim all qualifying medical expenses incurred. Taxpayers under 65 may claim medical aid contributions as a tax credit against tax payable as follows:

- R242 per month (up from R230) for each of the taxpayer and the first dependant;

- R162 per month (up from R154) for each additional dependant.

In addition the taxpayer can claim a deduction for the aggregate of medical scheme contributions exceeding four times the amount of the medical scheme fees tax credits and any other medical expenses, limited to an amount that exceeds 7.5% of the taxable income (excluding retirement fund lump sums). For taxpayers under 65 where the taxpayer or spouse or child is disabled, this last mentioned deduction is not capped.

Note – the Taxation Laws Amendment Act introduced medical tax credits for additional medical expenses which will be effective from 1 March 2014 (see ASAP on the Taxation Laws Amendment Act, 2012 for more detail).

4. National Health Insurance

Mention is made of the initial phase of the NHI development, which will not place a new revenue demand on the fiscus. This phase has been initiated in ten districts and includes improvements to health facilities, contracting with general practitioners and financial management reforms.

Over the longer term it is anticipated that a tax increase will be needed and the funding systems are currently being examined. A discussion paper welcoming public comment will be published later this year.

5. Business Taxes

Small business corporations will enjoy an increased tax-free threshold from R63 556 to R67 111. Taxable income up to R365 000 (up from R350 000) will be taxed at 7%. A new bracket is being introduced for income between R365 001 and R550 000, which will be taxed at 21%. All income in excess of R550 000 will be taxed at 28%. This will be effective for the year of assessment ending on or after 1 April 2013.

6. Retirement Reform Proposals

A further consultation period, where comment is invited, will close on 31 May 2013. Draft legislation to give effect to the proposals will be published during 2013 after all comments are considered.

In the new proposals there is reference to two effective dates:

 T-Day – Retirement Fund Contributions

T-day refers to the change in the treatment of retirement fund contributions and will be on or after 2015. On this day all employer retirement fund contributions will be included in the employee’s gross income as a fringe benefit. The employee will be entitled to a tax deduction for all contributions made to pension, provident or retirement annuity funds up to 27.5% of the greater of remuneration and taxable income (note the differentiation between the tax deduction applicable to taxpayers under the age of 45 and over 45 has been removed at this time). An overall ceiling of R350 000 will apply.

P-Day – Retirement Fund Preservation

P-day is the other relevant day which will change the rules of retirement fund preservation, which is also planned for 2015 or thereafter. After P-day all retirement funds will have to identify a preservation fund and the member’s funds will have to be transferred to the new employer’s pension or provident fund (where possible) or that preservation fund when they resign. Existing rules to preservation funds will be relaxed to allow for annual withdrawals, within certain limits. Payments resulting from divorce orders will also be transferred to these preservation funds.

After P-day there will also be new annuitisation rules in respect of provident funds. Full access will be restricted after this date. To limit the impact on provident fund members the minimum amount for full commutation will be increased from R75 000 to R150 000 (to apply at retirement).

Note that the fund value that accrued to a member prior to P-day will remain fully vested in the member and members that are older than 55 at the time will not be required to apply the new annuitisation rules.

Non-Retirement Savings

To encourage greater saving, tax-preferred savings and investment accounts are being proposed, which will encourage a new generation of savings products. Returns generated in these investments will be tax exempt and the withdrawals will also be free of tax. The design and costing of the products must ensure that lower income earners can also participate. Aggregate annual contributions could be limited to R30 000 per annum with a lifetime limit of R500 000 to ensure that high-earners to not benefit disproportionately.

The new accounts will be introduced in 2015 and it will co-exist with the current tax-exempt interest income dispensation.

7. Taxation of Trusts

The taxation of trusts will come under review to control abuse. Discretionary trusts should no longer act as a flow-through vehicle. Taxable income and loss (including capital gains and losses) should be fully calculated at trust level with distributions acting as deductible payments. Beneficiaries will be eligible to receive tax-free distributions except where it gives rise to deductible expenses. Trading trusts will also be taxed at entity level and distributions from offshore foundations will be treated as ordinary revenue.

8. Income Protection policies

A proposal is being made that all non-retirement fund disability and income-protection policies’ contributions will not be tax deductible and pay-outs will be tax exempt.

9. Other tax proposals

An employment incentive is being considered for first-time job seekers.

An overall increase of 23 cents per litre in fuel levies in April which includes an 8 cents per litre in the road accident fund levy.

An increase in excise duties on alcohol and tobacco products ranging between 5.7 and 10 cents.

Introducing a carbon tax in 2015 and phasing-out the electricity levy.

Modification is being proposed to the tax treatment of employment share schemes.

Market highlights

''Market highlights



Global markets consolidated last week after enjoying

solid gains in January. The MSCI World $ Index

declined 0.45%, leaving it up 4.98% for the year-todate.



The S&P 500 was up 0.31%, the Dow Jones Industrial

Average (DJIA) down 0.12% and the Nasdaq was up

0.93%. In European markets, the French CAC 40 was

down 3.29% and the Frankfurt DAX was down 2.31%.

In Asian markets, the Nikkei 225 was down 0.34% and

the Shanghai Composite Index up 0.58%.



The FTSE/JSE All Share Index gained of 0.72%.

Resources, financials and industrials gained 0.82%,

0.22% and 0.86%, respectively.



Chinese exports jumped 25% year-on-year and imports

28.80% in January giving the country a trade surplus of

$29.2 billion. Consumer prices eased from 2.5% in

January to 2% in December. The data suggested that

the authorities have the scope to retain accommodative

policy even as the economy accelerates.



Spanish and Italian bond yields climbed higher

triggered by a slush fund scandal potentially implicating

Spanish prime minister, Marian Rajoy, and worries over

the forthcoming Italian election. Rajoy faced calls for his

resignation following allegations of secret payments to

members of his party. In Italy, opinion polls showed''