Edition: September / November 2017

In-Fund Living Annuities: The Power of Scale

Just how attractive will an in-fund living annuity be for the average employee?
Freddy Mwabi, of Simeka Consultants & Actuaries, suggests that the answer will be particularly relevant if compulsory annuitisation of retirement benefits for provident funds becomes effective in March.

Late last year National Treasury published its second draft of the proposed retirement fund default regulations. One requirement is that the rules of pension, provident and retirement annuity funds make provision for an annuity strategy.

Living annuities may be offered in terms of the annuity strategy. However, preference is to be given to in-fund living annuities as these could offer much-improved cost efficiencies, seamless transition and the potential to give members a better retirement outcome than out-of-fund living annuities.


Trustees are in a position to offer in-fund living annuities to their fund members at highly competitive prices. In addition, when a member selects an in-fund strategy, there would typically be no additional administration fees or commissions. If the member chooses to make use of the services of a financial adviser, any advice fees can be paid from the benefit if so arranged.

On the other hand, should a retail living annuity be chosen, it may attract upfront administration fees and commissions. Ongoing platform and advice trail fees are also likely to be payable.

Consider the case of a member who has accumulated R1m at retirement and is faced with a choice of an in-fund living annuity or a retail living annuity. We assume the member chooses an initial drawdown rate of 7% (the average drawdown rate in South Africa according to research by ASISA) and a conservative annual increase at 50% of inflation. We also make the following assumptions regarding costs and investment returns:

Table 1: Assumptions In-fund Out-of-fund
Initial fees Nil Nil
Ongoing admin fees R150 p.m. increasing by CPI Nil
Platform fees Nil 0.5%
Ongoing advice fees Nil 0.75% of assets
Investment management fees 1% 1.50% of assets
Gross investment return CPI + 3.5% CPI + 3.5%

The result of the costs, annuity drawn and fund value projections are as follows after 10 and 20 years respectively:

  10 years 20 years
Table 2 Results In-fund Out-of-fund In-fund Out-of-fund
Total costs R122 000 R248 000 R241 000 R385 000
Total annuity drawn R780 000 R780 000 R1 795 000 R1 574 000
Fund value R967 000 R760 000 R541 000 R269 000

From these calculations we observe that due to higher costs, the fund value in the out-of-fund living annuity is 79% of the fund value in the in-fund annuity after 10 years. This figure drops further to 50% after 20 years.

The difference in costs also affects the income drawn from the annuity, as illustrated by the graph:

In this scenario, the initial drawdown amount in both funds increases at the same pace (50% of CPI) for the first 14 years. Subsequently, the annuity provided by the out-of-fund living annuity starts to decline as the fund value decreases to the extent that the required annual drawdown is greater than the maximum allowable 17.5% of assets.

Therefore, the member can only draw up to 17.5% of a decreasing pot each year. By comparison, the in-fund living annuity reaches the drawdown ceiling approximately five years later.

Over 20 years, the in-fund living annuity provides a greater total annuity drawdown (as shown in Table 2). Further, the drawdown provided by the out-of-fund annuity is approximately 50% of the income drawn from the in-fund annuity after 20 years.


Most employees require a certain amount in a cash lump sum when they retire, to prepare for and adjust to the next phase of their lives. But what do they do with the rest of their retirement benefit? They plan to invest it in some way to secure an income. Right?

Mwabi. . . impact on provident funds

Research tells us that the smart money will remain in the fund and will select the in-fund living annuity. Based on our research, a member is not likely to find a better combination of cost efficiency, flexibility and convenience in an annuity anywhere else in South Africa.

In this example, an efficiently priced in-fund annuity will offer the member 14% more in pension payouts over 20 years (R1 795 000 vs R1 574 000 in Table 2) than a typical out-of-fund alternative, leaving the member with double the assets (R541 000 vs R269 000, also in Table 2). The better option is clear.