How does a living-annuity drawdown work, and what is the risk?
A living annuity places the retiree in charge of their own pension. It requires the owner to choose how much of their invested capital to withdraw as income each year.
Because the money remains invested in the financial markets, the core risk is a mathematical one. Drawing money out faster than the investments grow causes the capital to deplete, raising the probability that the funds run out before the retiree dies.
The legal limits: 2.5% to 17.5%
South African tax law dictates that a living annuity must pay out an income; the money cannot just sit there indefinitely. The legislation requires the owner to choose a drawdown rate of between 2.5% and 17.5% of the total capital value per year.
This rate can only be adjusted once a year, on the policy anniversary. If a retiree chooses 5% and the cost of living suddenly spikes three months later, they are locked into that 5% withdrawal rate until the next anniversary date.
The maths of capital depletion
To sustain an income for decades, the investments inside the annuity need to generate growth. The financial balancing act involves comparing the withdrawal rate to the real return.
A portfolio must cover the drawdown rate, investment fees, and outpace inflation. If inflation is 5%, a retiree needs their income to increase by 5% every year just to afford the same basket of groceries. If a portfolio grows by 10%, but fees consume 1.5% and inflation is 5%, the real return is only 3.5%.
If the retiree withdraws 6% in that scenario, they are eating into their base capital. The following year, that 6% is calculated on a smaller capital balance, which means the physical Rand amount paid out drops. If the retiree then bumps their drawdown rate to 8% to maintain their cash income, the capital shrinks even faster.
The danger of bad timing (sequence of returns risk)
A common assumption is that long-term average market returns dictate how long the money lasts. In reality, the specific timing of those returns matters far more.
This is known as sequence-of-returns risk. If the stock market drops sharply in the first three years of retirement, the portfolio loses value at the exact same time the retiree is selling off units to fund their income. Selling investments while they are cheap locks in permanent losses, leaving a much smaller capital base to benefit from any future market recovery.
Conversely, if the market booms during the first few years of retirement, the capital base swells. This creates a large buffer, making it much easier for the portfolio to survive market crashes later in life.
South African realities vs the 4% rule
When looking at safe withdrawal rates, international literature often cites the American "4% rule." South African economics behave differently.
While the SARB targets inflation at 3% (with a 2–4% tolerance band), local historical inflation has often required portfolios to generate higher returns just to stand still. Consequently, local financial models typically stress-test starting drawdown rates closely around the 4% to 5% mark. The mathematics show that once a drawdown rate consistently climbs past 5% or 6%, the probability of capital exhaustion rises significantly.
The alternative: shifting the risk
The alternative to managing these risks manually is to purchase a guaranteed annuity.
In a guaranteed structure, the retiree hands their capital over to a life insurer. The insurer contractually guarantees a set monthly income for the rest of the retiree's life, entirely absorbing the sequence-of-returns risk and market volatility.
The structural trade-off is flexibility. In a guaranteed annuity, the retiree cannot change their income level, they cannot access emergency lump sums, and upon death, the capital generally belongs to the insurer rather than passing to their heirs.
Terms used on this page
- living annuity
- A retirement income product where the pot stays invested and you choose a yearly drawdown between 2.5% and 17.5%. The income isn't guaranteed — the pot can run out.
- drawdown
- The share of a retirement pot taken as income each year — and, in markets, the drop from a peak before recovery. Both uses matter in retirement.
- policy anniversary
- The annual date marking exactly one year since a financial policy or contract commenced.
- real return
- Growth after inflation — the increase in what your money can actually buy, not just the number on the statement.
- inflation
- The rate at which the general prices of goods and services in an economy increase over time.
- sequence-of-returns risk
- The danger of hitting negative investment returns early in retirement, which permanently shrinks the capital base while withdrawals are being made.
- South African Reserve Bank (SARB)
- The central bank of South Africa, responsible for managing the country's money supply and protecting the value of the Rand.
- guaranteed (life) annuity
- A retirement income product where an insurer pays a set income for the rest of your life in exchange for the pot. No market risk to you — but the capital is spent, and the income generally stops at death unless structured otherwise.
- volatility
- How much and how quickly an investment's price swings up and down. Higher volatility means a rougher ride along the way — not necessarily a different destination.
Sources
Reviewed July 2026