LIVING ANNUITIES IN SOUTH AFRICA: YOUR MOST FLEXIBLE RETIREMENT INCOME SOLUTION

How a Living Annuity Works

When you retire from a pension, provident, or retirement annuity fund, you are required to use at least two-thirds of the benefit to purchase an annuity. A living annuity is one of the two main options available (the other being a guaranteed life annuity).

Once your retirement capital is transferred into a living annuity, three decisions shape everything that follows.

1. Your Drawdown Rate

Each year, on your policy anniversary, you select an income drawdown rate between 2.5% and 17.5% of your fund value. That rate then applies for the full twelve months until the next anniversary, regardless of what markets do in the interim. Most retirees set this as a monthly income, though quarterly and annual payment options exist.

The drawdown rate is the single most important decision in a living annuity. Too high, and you’re eroding capital faster than your portfolio can replenish it. Too low, and you may be living more frugally than your portfolio actually requires. Getting this calibrated — and revisiting it honestly each year — is the ongoing discipline that determines whether a living annuity works over a 20- or 30-year retirement.

2. Your Investment Allocation

Unlike during the accumulation phase, living annuities are not subject to Regulation 28 — meaning there are no mandated limits on equity, offshore, or alternative allocations. You have full flexibility over how the capital is invested, which is a genuine advantage but also a genuine responsibility.

The investment allocation needs to balance two competing objectives: generating sufficient real growth to sustain income over a long retirement, while managing volatility in a way that doesn’t create forced selling at the wrong time. This is structurally different from accumulation investing, where time and continued contributions provide a buffer against bad periods. In retirement, the sequence of returns matters in a way it didn’t before.

3. What Happens on Death

Any remaining capital in a living annuity passes directly to nominated beneficiaries outside the estate winding-up process. This is one of the meaningful estate-planning advantages of a living annuity over other structures — beneficiaries can receive the capital promptly, and it bypasses executor fees on that portion of the estate. Keeping your nomination current is essential; without a valid nomination, the capital falls into the estate.

The Risks Retirees Most Often Underestimate

Living annuities carry real risks that are easy to underestimate at the point of retirement — particularly when markets have been behaving well and the income requirement feels manageable. Here are the ones that most frequently cause problems in practice.

Sequence of Returns Risk

This is perhaps the most important concept in retirement income planning, and the one that surprises retirees most. The concern isn’t just about average returns over time — it’s about the order in which returns arrive.

Consider two retirees who both earn an identical average annual return of 7% over twenty years, but in opposite sequences — one experiences strong early years followed by poor ones; the other the reverse. The retiree who faces poor returns early, while simultaneously drawing income, can suffer permanent capital damage that the later recovery never fully repairs. The withdrawals lock in losses that compound against the retiree over time.

This is why the early years of a living annuity matter disproportionately. A significant drawdown in the first three to five years of retirement, combined with income withdrawals, can set a portfolio on a trajectory it cannot recover from — even if the subsequent decades produce perfectly acceptable returns.

Longevity Risk

Most people underestimate how long their retirement will last. A 65-year-old in reasonable health today has a meaningful probability of living into their mid-to-late eighties — a 20- to 25-year retirement is not unusual, and a 30-year retirement is not rare. A drawdown rate that looks sustainable at 65, assuming a 15-year time horizon, looks very different if the actual horizon turns out to be 25 years.

This isn’t pessimism — it’s arithmetic. The appropriate drawdown rate depends critically on how long the capital needs to last, and most initial drawdown decisions are made with insufficient attention to the realistic upper end of that range.

Concentration Risk in a Portfolio That Looks Diversified

A growing concern, particularly among retirees who manage their own living annuity portfolios, is the risk of apparent diversification that is actually concentration in a narrow set of return drivers.

The proliferation of low-cost global index funds has been genuinely beneficial for investors. But many portfolios that hold, say, an S&P 500 fund, an MSCI World fund, and a Nasdaq ETF are not as diversified as they appear. The underlying holdings of these indices overlap significantly — the same handful of large-cap technology companies often represent a disproportionate share of all three. In a significant equity drawdown, portfolios structured this way tend to move together in ways that simple label-level diversification doesn’t reveal.

For an accumulator with a 20-year horizon and no income withdrawals, this concentration is uncomfortable but manageable — time allows recovery. For a retiree drawing income simultaneously, forced selling at depressed prices during a prolonged bear market can produce permanent impairment. The structural difference between accumulation and retirement means the same portfolio, managed identically, carries very different risk in the two phases.

What Makes a Drawdown Rate Sustainable?

The regulatory floor of 2.5% and ceiling of 17.5% define the permitted range — but they say nothing about what’s actually sustainable for a given individual. Sustainability depends on the interaction of several factors that no single rule of thumb can adequately capture.

Why Simple Rules Fall Short

The “4% rule” — popularised by US financial planning research — is widely cited in retirement discussions and widely misapplied. It was derived from a specific historical dataset (US market returns from 1926), using a specific portfolio (60% equities, 40% bonds), over a specific time horizon (30 years). Apply it to a South African investor with a different asset mix, a potentially longer time horizon, and a different fee structure, and you’ve borrowed a conclusion without importing its assumptions.

The more useful framing is not “what percentage is safe?” but “what do I actually need to draw, and what return does my portfolio need to generate to sustain that over my realistic time horizon, after fees and inflation?” That’s a modelling exercise, not a rule-of-thumb exercise.

The Variables That Actually Determine Sustainability

As a general orientation — not a rule — Henceforward’s view is that drawdown rates below 5% are typically sustainable for well-constructed portfolios with appropriate growth exposure; rates in the 5–6% range require active monitoring and a willingness to adjust; and rates consistently above 7% are difficult to sustain over a 20+ year retirement unless the portfolio is generating exceptional real returns, which itself introduces the kind of risk that retirees are usually trying to avoid.

These ranges assume a total cost structure (platform + fund + advice) well below 2% per annum. At higher total costs, the sustainable drawdown rate falls accordingly.

Investment Strategy Inside a Living Annuity

The most common mistake in living annuity portfolio construction is treating it as a continuation of the accumulation portfolio. It isn’t — the objectives, constraints, and risk characteristics are fundamentally different once income is being drawn simultaneously.

Growth Still Matters — Perhaps More Than People Realise

The temptation in retirement is to de-risk dramatically — moving heavily into income-generating or capital-preservation assets to reduce volatility. This is understandable psychologically but often counterproductive over a long retirement. A portfolio that is too conservative erodes in real terms, year after year, as inflation gradually outpaces returns. A retiree at 65 who moves entirely into cash or bonds may feel safer in the short term but faces a very different kind of risk over a 25-year horizon: that the capital base gradually declines in purchasing power, and income that felt adequate at 65 becomes insufficient at 80.

The appropriate response is not maximum equity exposure — it’s calibrated exposure to growth assets, managed in a way that doesn’t create forced selling during drawdowns.

Managing Volatility Without Eliminating Growth

Several structural approaches help manage the tension between growth and volatility in a living annuity:

• Maintaining a cash or near-cash buffer — typically 12 to 24 months of income — means that in a down market, income can be drawn from the buffer rather than selling growth assets at depressed prices. This breaks the forced-selling dynamic that makes sequence risk so damaging.
• Genuine diversification across return drivers — not just labels, but actual underlying exposures. A portfolio with meaningful allocations to different geographies, asset classes, and investment styles behaves differently under stress than one that appears diversified but derives most of its return from the same narrow set of drivers.
• Offshore exposure — South Africa represents a small and concentrated market. Meaningful offshore allocation provides access to a broader opportunity set and reduces the correlation between your income structure and a single economy’s fortunes.
• Regular rebalancing — ensures that a strong run in one asset class doesn’t silently increase concentration risk over time, and that the portfolio’s risk profile stays aligned with the original intention.

The Fee Drag Problem

Fees in a living annuity compound against you in the same way that investment returns compound for you. A total fee structure of 1.5% per annum versus 0.75% per annum — a difference of 75 basis points — can mean a materially different capital position over 20 years, particularly when combined with income withdrawals. The arithmetic is not forgiving, and the impact of fees is frequently underestimated by investors who focus on gross returns rather than what they actually net after all costs.

Total fee drag — the sum of platform, investment, and advice fees — should ideally sit well below 2% per annum on a living annuity portfolio. Above that level, the effective sustainable drawdown rate begins to compress meaningfully.

Who Is a Living Annuity Suitable For?

A living annuity is not the right structure for every retiree. The flexibility it provides comes with genuine responsibilities — and for some people, those responsibilities are better transferred to an insurer through a guaranteed life annuity instead.

In practice, many retirees benefit from a blended approach — using a guaranteed life annuity to underpin non-negotiable monthly expenses, and a living annuity for flexibility, growth, and legacy. This isn’t a compromise; for many circumstances it’s actually the most structurally sound approach, because it transfers the risks that genuinely need to be transferred (longevity risk on essential income) while retaining the flexibility that has real value (adjustable income on discretionary spending, estate planning benefits on residual capital).

Living Annuities in a Broader Retirement Plan

A living annuity should not exist in isolation. It is one component of a retirement income strategy that needs to account for cash flow, tax, estate, and longevity considerations simultaneously.

The decisions made at the point of retirement — drawdown rate, investment allocation, product structure — have compounding consequences over a 20- to 30-year horizon. Revisiting them regularly, with an honest assessment of both portfolio performance and actual spending, is the ongoing work that determines whether a living annuity delivers on its potential. Our retirement planning guide sets out the broader framework that a living annuity sits within.