As you approach retirement you will face a decision that will largely determine how you live out your golden years; namely, what to do with the retirement nest egg you have built up over the years.

According to legislation, on retiring, you are required to buy an annuity with at least two-thirds of your retirement capital that you have accumulated in your pension fund or retirement annuity (if you were contributing to a provident fund, you are allowed to withdraw the whole amount at retirement).

The purpose of the annuity is to provide you with an income on retirement from capital you have accumulated over the years in your various retirement vehicles.

Your choice will determine your future

Says PPS Investments Head of sales, Nico Coetzee: "The type of annuity you choose will have a significant impact on whether you are able to maintain your standard of living."

There are two main types of annuities available — living and guaranteed. A living annuity allows you to select a rate of income annually which is withdrawn from your capital while a guaranteed annuity provides you with a stipulated income for the rest of your life.

"Both these annuities have a place in the market," says Coetzee. "A deciding factor will be the level of control that you want over your post-retirement savings."

With more control comes more responsibility

He says that if you want to have a high degree of control over your income each year, and would like to grow your post-retirement income, then a living annuity may be appropriate. "Always bear in mind that with more control comes more responsibility."

With a living annuity it is up to you to determine how much of your capital you draw each year, which can be between 2.5 percent and 17.5 percent of the annual capital value of the annuity. This income can be paid out annually, half-yearly, quarterly or monthly. "You must review the annuity amount every year and you need to carefully manage your income so that you do not run out of capital," cautions Coetzee.

A living annuity also provides you with far more investment choice than a traditional guaranteed annuity. It therefore requires you to play a more active role in ensuring you have sufficient money on which to live until the day you die. "You are in charge of the underlying investment choices. You can select and change the underlying investments at your discretion within the options available from your annuity provider," says Coetzee. "One option is to invest in a balanced fund that provides some growth, helping your capital to keep pace with inflation, while at the same time offering protection in falling markets."

Unlike a guaranteed annuity, when you die what's left in your living annuity is passed on

Finally, unlike a guaranteed annuity, when you die the amount left in your living annuity is passed on to your beneficiaries. This amount can be passed on as an ongoing annuity to generate an income, or as an accelerated annuity that pays out all the capital and investment growth over five years. The residue is not taxable in your estate, but will be treated as income in the hands of your beneficiaries who will be taxed at their marginal tax rates.

Coetzee says that while living annuities have the edge in many respects, if you want a guaranteed income for the rest of your life and do not want to get involved in managing your retirement capital then a guaranteed annuity would be appropriate. "Your income is determined by interest rates on the day that you retire and your monthly income stays the same. This option may suit investors who require the certainty of a fixed income," says Coetzee, who cautions that one of the drawbacks is that your income may not keep pace with inflation.

"Like all major financial decisions, it is important that you contact an accredited financial advisor who can assist you in selecting an annuity that best meets your needs."

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