Life Annuity vs Living Annuity: Choosing Your Retirement Income Option

By / September 24, 2025

Retirement is not the finish line; it is a change in how you receive and manage income. In South Africa, […]

Life Annuity vs Living Annuity Choosing Your Retirement Income Option

Retirement is not the finish line; it is a change in how you receive and manage income. In South Africa, most people who save in retirement funds (pension, provident, preservation, or retirement annuity funds) must convert at least two-thirds of their accumulated savings into an income-paying product at retirement. For most retirees, the practical choice is between a life annuity (also called a guaranteed annuity) and a living annuity (also called an investment-linked annuity). These products solve the same problem in very different ways. This guide explains how each option works, the trade-offs, how tax and the new two-pot system fit in, and a simple, decision-ready framework to help you choose with confidence.

What each product is (in plain English)

Life annuity (guaranteed annuity)

A life annuity is an insurance contract that swaps a lump sum for a guaranteed income for life. The insurer takes on the longevity risk (you cannot outlive the income), the investment risk (market ups and downs), and the sequence-of-returns risk (bad early returns). In exchange, you give up capital access and flexibility.

Common variations:

  • Level life annuity: Income stays the same in rand terms. It buys less over time if inflation is high.
  • Escalating annuity: Income increases by a fixed percentage each year (for example 5%).
  • Inflation-linked annuity: Income tracks CPI, so purchasing power is protected.
  • With-profit life annuity: Income and annual increases are linked to the performance of an underlying portfolio, with increases smoothed; once increases are granted they are usually guaranteed thereafter.
  • Single vs joint life: Income can be guaranteed for one life or continue to a spouse or partner at a chosen percentage.
  • Guarantee period: You can add a 5-, 10-, or 15-year minimum payment period; if you die during this period, payments continue to your beneficiaries for the balance.

Key idea: Predictability and peace of mind, in exchange for less flexibility and no direct access to capital.

Living annuity (investment-linked annuity)

A living annuity is an investment account (held via an insurer or retirement fund platform) from which you draw a self-selected income each year. Your capital stays invested in market portfolios which you can usually switch. You decide how much income to draw within a legally defined band, and you carry the risk that your capital may run out if markets underperform, inflation bites, or withdrawals are too high.

Key features:

  • You set the drawdown each policy anniversary (between the minimum and maximum set in law).
  • Investment choice and asset allocation are up to you (and your adviser, if you have one).
  • Capital remains accessible only via the scheduled income, not ad hoc withdrawals (with a small-balance cash-out exception).
  • On death, remaining capital generally passes to nominated beneficiaries, who can elect cash or to continue the annuity (rules differ for in-fund vs insurance living annuities).

Key idea: Flexibility and legacy potential, in exchange for taking on market, inflation, and longevity risks yourself.

The new two-pot retirement system: what it changes (and what it does not)

South Africa’s two-pot system took effect on 1 September 2024. During your working years, your contributions are split into a savings component (limited access before retirement) and a retirement component (preserved for retirement and must be annuitised when you retire, subject to the small-fund exception). This reform mostly affects how money flows into retirement, not the choice between a life annuity and a living annuity at retirement. The requirement to convert the bulk of your retirement component into an annuity remains in place (again, except where your total retirement interest is below the de minimis threshold).

Rules that shape your choice (must-know facts)

  • Annuitisation threshold at retirement: If your total retirement interest in a fund is R247 500 or less, you may generally take it fully in cash instead of buying an annuity. Otherwise, at least two-thirds must be used to purchase an annuity (or annuities).
  • Living annuity drawdown band: You may choose an annual income between 2.5% and 17.5% of the living annuity’s market value at each policy anniversary.
  • Small-balance cash-out from a living annuity: If the remaining value of a living annuity falls below R125 000 (aggregated per insurer), it may be fully commuted for a lump sum.
  • Life annuity commutation: A standard compulsory life annuity is non-commutable during your lifetime (you cannot swap it back for cash), except in narrow legacy cases.
  • Transfers and conversions: You can transfer a living annuity between providers. You can convert a living annuity to a life annuity (often irrevocably). You cannot convert a life annuity back to a living annuity.

These rules are set in tax and pension legislation and are enforced through the FSCA and SARS frameworks. See the Sources for the official references.

Tax: how your income is taxed from each annuity

  • Income tax: Whether you choose a life annuity or a living annuity, the income you receive is taxed as ordinary income at your marginal rate, with PAYE withheld. You can request the payer to use a higher PAYE rate if you have other taxable income.
  • Inside the product: There is no income tax, dividends tax, or CGT inside the annuity wrapper. Tax applies only when income is paid to you, or when a commutation lump sum is taken (small balance or death settlement).
  • Lump sums: If you commute a small living annuity or take any retirement lump sums, these are taxed against the retirement lump-sum tax tables (separate from normal income tax).
  • Non-residents: If you retire in South Africa and later become tax non-resident, annuity income sourced from South Africa is generally taxable in South Africa (treaty relief may apply).

Estate planning: what happens when you die

  • Life annuity: Payments typically stop on death unless you selected a guarantee period or a joint-life option. There is usually no capital value to bequeath beyond these guarantees.
  • Living annuity: The remaining value passes directly to your nominated beneficiaries (or is distributed by fund trustees for in-fund living annuities). This is typically outside your estate for estate duty purposes when paid to natural persons, although excess contributions and certain scenarios can create exceptions. Beneficiaries may choose a lump sum (taxed per lump-sum tables) or continue receiving annuity income (taxed as income).

Pros and cons at a glance

FeatureLife AnnuityLiving Annuity
Income certaintyHigh: guaranteed for lifeVariable: depends on markets and drawdown
Inflation protectionChoose level, fixed escalation, CPI-linked, or with-profitNot automatic; depends on returns vs withdrawals
Longevity riskInsurer carries itYou carry it
Investment controlNoneHigh (you select investments)
FlexibilityLow (irreversible)High (annual drawdown, switch funds, transfer providers)
Legacy potentialLimited (unless guarantee period or joint-life)High (residual capital to beneficiaries)
Behavioural riskLowHigh (overspending, poor asset mix)
FeesEmbedded in pricing; no explicit platform feeTransparent advice, platform, and fund fees
Small-balance exitNot available (generally)Possible below R125 000
Best suited toCovering essential lifetime expensesDiscretionary spending, legacy, and flexible needs

How to decide: a practical, three-bucket framework

Many retirees combine both products to match needs and risks:

  1. Essential expenses bucket
    Cover the basics that must be paid for as long as you live (food, housing, utilities, medical scheme premiums, transport, and non-discretionary costs). A CPI-linked life annuity (or a with-profit annuity with a strong increase track record) is well suited here.
  2. Lifestyle and discretionary bucket
    Holidays, gifts, home upgrades, and non-essential costs. A living annuity provides flexibility to adjust drawdowns and portfolio risk through time.
  3. Contingency and legacy bucket
    Unexpected medical costs, family help, or bequests. This may sit inside your living annuity (lower drawdown, moderate growth assets) or outside the annuity as discretionary investments.

Rule of thumb: Secure enough guaranteed income to sleep well at night, then use a living annuity for the rest.

What a sustainable drawdown looks like

The legal maximum is 17.5%, but that is rarely sustainable. Sustainable drawdown depends on inflation, fees, market returns, and lifespan. In South Africa, industry data and actuarial research indicate that static drawdowns above roughly 5% to 6% (before fees) materially increase the risk of depletion over a typical 25- to 35-year retirement, especially if inflation is high or returns are weak. A dynamic drawdown approach that adjusts income after poor markets can improve outcomes. If you need a higher permanent income, consider converting part of your capital to a life annuity instead of stretching a living annuity beyond a safe range.

Worked examples (illustrative only)

These are simplified examples to show the trade-offs. Actual quotes depend on age, gender, spouse cover, guarantee periods, escalation choice, interest rates, and insurer pricing. Always obtain personalised quotations.

Example A: Cover the essentials with a life annuity; keep flexibility with a living annuity

  • Capital at retirement: R3 000 000
  • Plan: Use R1 500 000 to buy a CPI-linked joint-life annuity (spouse 75% continuation), and place R1 500 000 into a living annuity.
  • Outcome:
    • The life annuity covers medical aid, rates and taxes, groceries, and utilities with inflation-protected certainty for both lives.
    • The living annuity funds travel and discretionary spending, with the option to reduce drawdown after poor markets, change asset allocation, or leave a legacy.

Example B: Living annuity only, with prudent drawdown

  • Capital: R2 000 000
  • Drawdown: Start at 4% (R80 000 per year), review annually, aim to keep drawdown within 3.5%–5% as far as possible.
  • Portfolio: Balanced growth with global diversification, fees < 1% all-in.
  • Risk controls: Reduce drawdown after negative years, keep at least two years’ income in lower-volatility assets, and set a hard ceiling (for example 6%).
  • Outcome: Higher flexibility and potential legacy, but you must actively manage risk to avoid sequence-of-returns pitfalls.

Example C: Life annuity only

  • Capital: R1 000 000
  • Product: With-profit life annuity with 10-year guarantee period, single life.
  • Outcome: Maximum simplicity and income certainty, minimal management. Limited or no residual capital for heirs (unless death occurs during guarantee period).

Fees and value for money

  • Life annuity: The guarantee is priced into the annuity rate. You do not see an explicit platform fee, but you are paying for longevity pooling and market risk transfer. Comparing quotes across insurers on the same day, with the same options (escalation, guarantee period, joint-life), is essential.
  • Living annuity: You will see platform fees, advice fees, and fund TERs. Lower fees improve sustainability. Before committing, ask for the all-in fee in rand terms and as a percentage of your capital, and model its impact on income longevity.

Governance, defaults, and consumer protections you should know about

  • Default annuity strategies: Many retirement funds must offer a default annuity or a guided pathway at retirement, including in-fund living annuities with monitored drawdowns and communication duties if your drawdown is deemed unsustainable.
  • Suitability and disclosures: Providers and advisers must give clear, comparable disclosures (for example ASISA living annuity standards). For with-profit annuities, review the increase formula, smoothing approach, participating portfolio, and historic increases.
  • Transfers and conversions: There are processes and protections when moving a living annuity or converting part of it to a life annuity. Conversions are typically one-way and irrevocable; check the small-balance and aggregation rules.

Decision checklist (use this with your adviser)

  1. Map your expenses into essential vs discretionary.
  2. Stress-test your living annuity plan at different inflation and return scenarios; check the chance of depletion at your chosen drawdown.
  3. Request comparable life annuity quotes (same escalation option, same guarantee period, same joint-life terms) from multiple insurers.
  4. Consider a hybrid: secure essentials with a life annuity, keep flexibility for the rest.
  5. Set a drawdown policy for a living annuity: starting rate, ceiling, and rules to cut income after negative market years.
  6. Audit fees: total annual rand fees and % of capital; seek cost-effective funds and platforms.
  7. Check beneficiary nominations and understand estate implications for your specific product (in-fund vs insurance policy).
  8. Plan for medical inflation: CPI-linked or with-profit life annuities help protect purchasing power for healthcare costs.
  9. Review annually: life changes, markets move, and your plan must adapt.
  10. Document everything and keep your spouse or partner involved.

Frequently asked questions

Can I have both a life annuity and a living annuity?
Yes. You can buy multiple annuities at retirement. Many retirees buy a life annuity for essentials and keep a living annuity for flexibility and legacy.

Can I change my mind later?
You can generally convert a living annuity to a life annuity, but you cannot convert a life annuity back to a living annuity. Treat a life annuity as irreversible.

What is a safe drawdown in a living annuity?
There is no one-size-fits-all answer. In practice, 3.5%–5% starting drawdowns are often used to balance income and sustainability, with dynamic adjustments after poor markets. If you need more than that for essentials, consider annuitising more capital.

How are my beneficiaries taxed on a living annuity when I die?
If they take a lump sum, tax is per the retirement lump-sum tables. If they continue the annuity income, it is taxed as income at their rates. Estate duty treatment depends on the specifics (for example, nominee is a natural person, excess contributions), so get personalised advice.

Does the two-pot system force me into one option?
No. It changes pre-retirement flows and access. At retirement you will still choose between a life annuity, a living annuity, or a combination, subject to the same small-fund exceptions and annuitisation requirements.

What if my living annuity drops below R125 000?
Then, subject to the rules (including aggregation across contracts at the same insurer), you may commute it for a lump sum taxed per the retirement lump-sum tables.

Putting it all together

  • Choose a life annuity if you value certainty, want to eliminate the risk of running out of money, and can give up capital access. Consider CPI-linked or with-profit options for inflation protection.
  • Choose a living annuity if you need flexibility, want investment control and legacy potential, and are comfortable managing drawdown risk with a disciplined plan.
  • Consider a hybrid to secure essentials for life while keeping flexibility for the rest. In practice, this is the most robust fit for many South African retirees.

Your retirement income decision is high-stakes and largely one-time. Run the numbers with an experienced, fee-transparent adviser, stress-test the plan, and document a drawdown policy you can stick to. A well-matched annuity strategy will feel boringly reliable through storms and sunshine, which is exactly what your future self needs.

Sources

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