Living annuities have long posed a challenge in South African divorce proceedings. Unlike pension interests in retirement funds, which are clearly regulated under the Divorce Act and the Pension Funds Act, living annuities occupy a grey area -neither fully pension assets nor entirely personal investments.
Before delving into the modern context, it’s crucial to understand the pre-existing issue: a living annuity is essentially an agreement with an insurer to pay an income stream (subject to drawdown limits) from an underlying investment portfolio. The capital underlying the living annuity policy legally vests in the insurer, not the annuitant, who only possesses the right to the future income stream.
Pre-Montanari: The legal ambiguity
Prior to the 2020 Supreme Court of Appeal (SCA) judgment in Montanari v Montanari, living annuities were generally excluded from the definition of “pension interest” under the Divorce Act. In 2016 the Johannesburg High Court ruled that living annuities should not be taken into account for the purposes of calculating the assets in divorce proceedings.
In this there was an obvious injustice that, during membership of a fund, the non-member spouse has a right to share in the pension interest. However, when a living annuity is purchased from an insurer at retirement, then that right ends. In this way assets could be hidden by purchasing a living annuity and then claiming that it does not form part of the accrual during marriage.
The Montanari Judgment: A turning point
The Montanari judgement fundamentally altered the landscape. The court held that although a living annuity is not a “pension interest” as defined in the Divorce Act, it is nonetheless an asset comprising the right of the annuitant to receive a future income stream generated by the investment, and forms part of their estate for accrual purposes.
Crucially, the judgment clarified that the value of the living annuity must be included in the calculation of the accrual, even though the annuitant does not own the underlying capital. The court reasoned that the annuitant has a contractual right to receive income from the annuity, and this right has a quantifiable value. This opened the door to treating living annuities as matrimonial assets, subject to division under the accrual system.
Valuation of living annuities
Unlike a retirement fund, which often has a clear fund value, a living annuity involves a stream of future income payments based on a notional capital held by the insurer. The annuitant cannot access the capital directly, nor can they transfer it. On death the remaining capital is distributed to the beneficiaries nominated by the annuitant, which will probably exclude the former spouse.
The valuation of a living annuity typically requires an actuarial calculation to determine the present value of the annuitant’s right to receive the future annuity payments, taking into account the following:
The current drawdown rate
- The underlying investment portfolio
- The annuitant’s age and life expectancy
- Inflation assumptions
- Expected investment returns
- The tax rate of the annuitant
Stephen Walker, the Chair of the Retirement Matters Committee of the Actuarial Society of South Africa, stated that they are working with the Society’s Damages Committee to provide guidelines to actuaries to perform such valuations. Actuaries have discretion to apply reasonable methods to perform such valuations.
Even though the future income stream is valued, the current value of the investment account should also be considered. It is advisable that the actuary show the sensitivity of the value to various drawdown rates which may be chosen by the annuitant, as well as the impact of tax.
While not legally mandated, actuarial input is highly advisable, especially in high-value divorces or where the living annuity is a significant portion of the estate.
Division at divorce
The valuation forms part of the annuitant’s estate for accrual calculation, but the living annuity itself cannot be split directly. The non-member spouse’s right to their portion of the accrual must be settled through the distribution of other assets in the estate (for example, cash, property or other investments).
Treatment on death
Living annuities also raise questions in the context of death. Upon the annuitant’s death, the remaining capital is paid to nominated beneficiaries. If the divorce settlement includes a clause regarding the annuity, it’s essential to update beneficiary nominations to reflect the agreement. Failure to do so can result in unintended consequences, such as an ex-spouse receiving benefits contrary to the divorce order.
In some cases, the divorce order may stipulate that the annuitant must nominate the former spouse as a beneficiary for a portion of the annuity. While legally permissible, this must be carefully drafted and coordinated with the insurer to ensure enforceability.
Conclusion
The Montanari judgment has brought much-needed clarity to the treatment of living annuities in divorce settlements, affirming their status as matrimonial assets in accrual calculations. However, their unique structure demands careful valuation and thoughtful legal drafting. Actuaries and financial advisors play a crucial role in ensuring fair and defensible outcomes. As living annuities become more prevalent in retirement planning, their treatment in divorce will remain a critical issue for practitioners across the pensions and legal industries.