The impact of the new withdrawal limits

Government has reduced the annual pension withdrawal from a living annuity from between 5% and 20% to between 2.5% and 17.5%. How will this proposed change affect individual living annuity holders ? FAnews asked Alan McCulloch and Martin Oakes, both trustees of various Funds, and Chair and member, respectively, of the FPI Employee Benefits ISG to share their insights.

The change to Addendum B to RF 1 of 96, dated 21 February 2007, indicates that the new levels of drawing came into effect on 1 March 2007. It applies to all new living annuities purchased on or after that date and which must contain a clause enforcing any future adjustments of the drawing rates.

Existing contracts

In the case of existing living annuity contracts, the current limits of 5% and 20% can still apply as most insurers have clauses in their annuity contracts stating these limits and it is not within their power to vary them. However, if changes to the drawing level of an existing living annuity are required, the annuitant must agree to be bound by the new lower income levels and any subsequent adjustments to the rates.

The existing range of withdrawal rates from a living annuity was set in times of higher inflation than we experience today when investment returns in the order of 15% to 20% were quite common. In today's much lower inflationary environment such returns, whilst still possible given the recent long bull market, are no longer so common.

The reasons

Also, we need to consider why this change came about. In fact SARS considered the pre-existing upper limit of 20% too high in today's investment climate such that it was considering such living annuities not to be an annuity at all. It wanted to reduce the upper limit to at least 15%. The actual rates announced, therefore, represent something of a compromise.

Insurers face a challenge

There is an important caveat to the change in that insurers are required to ensure that at all times there is sufficient capital remaining as to ensure an income for life. Given the fact that the member contractually decides the rate at which the annuity is taken, and also the investment portfolio in which it can be invested (within certain limits), quite how insurers are supposed to police such a requirement is questionable.

Tax implications

The revised minimum level of drawing of 2,5% is welcome. Many annuitants in receipt of an income from a Living Annuity don't actually need the extra cash flow but have to take an annuity upon retirement. They have other sources of income, which means that the living annuity income is just taxed at 40%. So reducing income by 50% - from 5% down to 2.5% - will cut the tax bill. Of course though, the tax will eventually have to be paid.

Expats

A high withdrawal rate is appropriate in certain circumstances where the annuitant retires or lives overseas. As the Living Annuity is not commutable, the overseas annuitant is forced to carry the currency risk of the assets left behind in South Africa.

Common wisdom is that the Rand is in a long-term decline and such annuitants will not welcome the reduction in income as the maximum draw is reduced from 20% to 17.5% - very relevant to an annuitant returning to a hard-currency area.