Living annuity policyholders opt for lower income levels

30 May 2013 Peter Dempsey, ASISA
Peter Dempsey, deputy CEO of ASISA.

Peter Dempsey, deputy CEO of ASISA.

Living annuity policyholders withdrew on average 6.77% of their investments as income in 2012. According to the 2012 Living Annuities Survey released this week by the Association for Savings and Investment South Africa (ASISA) this represents a marginal r

Peter Dempsey, deputy CEO of ASISA, says the average drawdown level was measured in monetary terms taking into consideration the total value of the drawdowns against the total value of the living annuity book. Important to note, he adds, is that costs were excluded from the drawdown levels.

“We only took into consideration drawdown percentages selected by policyholders. Costs were excluded since these vary from company to company and the advice fee is negotiable between the client and the adviser.”

By law living annuity policyholders must draw a regular income of between 2.5% and 17.5% of the investment value of the assets if the living annuity policy was bought on or after 21 February 2007. This can be reviewed once a year on the anniversary date of the policy. Policyholders who bought their living annuities before this date are still allowed to draw income at the old levels of between 5% and 20% provided no changes are made to the selected income levels.

Dempsey explains that the Living Annuities Survey makes it possible for ASISA to monitor the level of income drawn by policyholders from their retirement capital as well as the asset composition of living annuity investment portfolios.

“Although the gradual reduction in the average drawdown rate from 6.99% in 2011 to 6.77% in 2012 is encouraging, ASISA would like to see an average drawdown rate closer to 5%,” comments Dempsey.

“The survey shows that the risk of living annuity policyholders eroding their capital too quickly by drawing too much income is not as high as previously thought. However, the current average drawdown levels of 6.77% combined with costs and inappropriate asset composition still put the policyholder at risk of eroding capital too quickly in real terms should drawdown rates exceed expected returns.”

Dempsey says fortunately for policyholders the value of the average monthly drawdown increased by 10% from R3 352 in 2011 to R3 690 in 2012 even though the percentage drawdown rate reduced slightly. “This clearly reflects an overall net increase in asset values of more than 10% over the year.”

Risking capital

Dempsey points out that while adhering to prudent investment guidelines within a living annuity is not a legal requirement, policyholders are strongly advised to take them into consideration. The survey shows that 18.6% of policies did not comply with the prudent asset composition as recommended by ASISA:

• A maximum 75% equity exposure;

• A maximum 25% property exposure; and

• A maximum 25% exposure to offshore assets.

Dempsey also points out that averages do not apply to everyone and that there is evidence of policyholders with smaller portfolios applying higher percentage drawdowns than policyholders of larger portfolios.

The survey results show that, on average, clients with the larger asset values tend to apply drawdowns of less than 7.5%, and as the drawdown percentages increase the average asset values progressively decrease. This is true for all age bands. (See table below.)

“Unfortunately consumers who have not saved enough for their retirement often turn to living annuities for the wrong reason. Being able to draw a higher income from a living annuity than would be available from a traditional compulsory annuity may help someone who does not have enough retirement capital maintain a certain lifestyle in the early years. But hardship will follow when the capital has been depleted over a short period of time.”
Dempsey says policyholders who are assisted by a financial adviser generally select lower levels of income since they better understand the long-term implications.

Other reasons why people opt for higher drawdown levels include:

• Wealthier people have other sources of income and therefore do not need to draw on their living annuity to the same extent as poorer people.

• Less wealthy people could have a poorer understanding of the dynamics of living annuities.

• Since legislation makes it difficult to consolidate several living annuities, some people may be taking large drawdown percentages to close down small living annuities derived from small retirement annuities.

Living annuities in numbers

At the end of last year, South Africans had R191.2 billion of their retirement savings invested in some 305 145 living annuities. In 2011 some 278 000 living annuities held assets of R155.2 billion. In 2012 alone living annuities attracted new inflows of R27.1 billion compared to R23.9 billion in 2011.

In terms of the ASISA Standard on Living Annuities, which came into effect in 2010, member companies must provide a living annuity status report to ASISA at the end of each year. Dempsey says at the end of 2012 all ASISA member companies that offer living annuities complied with this requirement. Consolidated reports now exist for 2011 and 2012.

What is a living annuity?

A living annuity is defined as a special type of compulsory purchase annuity that does not guarantee a regular income. Capital preservation is dependent on the performance of the underlying investments and a reasonable income drawdown level.

Three key factors determine how long the capital will be able to produce a regular income:

• The level of income selected;

• Performance of selected investments;

• The lifespan of the annuitant.

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