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Living annuity policyholders opt for lower income to preserve capital

23 June 2014 Peter Dempsey, ASISA
Peter Dempsey, deputy CEO of ASISA.

Peter Dempsey, deputy CEO of ASISA.

Average income drawdown levels for living annuities continued their downward trend in 2013. The 2013 Living Annuities Survey released by the Association for Savings and Investment South Africa (ASISA) this week shows that living annuity policyholders withdrew on average 6.63% of their capital as income in 2013, compared to 6.77% in 2012 and 6.99% in 2011.

Peter Dempsey, deputy CEO of ASISA, says although the reduction in drawdown levels is marginal, it is still encouraging. “Ultimately we would like to see an average drawdown rate closer to 5%. Every reduction, no matter how small, brings us closer to this goal,” says Dempsey.

He says while averages do not apply to everyone, by far the majority of living annuity policyholders risk eroding their capital by drawing more than 5% as income.

“Policyholders need to ensure that drawdown rates never exceed expected returns in order to preserve their capital,” says Dempsey.

Fortunately for policyholders, in 2013 living annuity portfolios achieved an average return of 10% after taking into account all fees of the underlying investment instruments. As a result the value of the average monthly drawdown increased from R3 489.75 in 2012 to R3 949.93 in 2013, even though the percentage drawdown rate reduced slightly.

The survey took into consideration drawdown percentages selected by policyholders, but excluded platform and adviser charges 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 says 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. Financial advisers would also help their clients decide against which of the underlying funds the elected income drawdown should be made and in what proportion.

Living annuities in numbers

At the end of last year, South Africans had R240.7 billion of their retirement savings invested in 339 724 living annuities. In 2012 some 305 145 living annuities held assets of R191.2 billion. In 2013 alone living annuities attracted new inflows of R44.2 billion compared to R27.1 billion in 2012.

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 2013 all 23 ASISA member companies that offer living annuities complied with this requirement.

Prudent guidelines

The Living Annuities Survey also helps ASISA monitor the asset composition of living annuity investment portfolios.

Unlike retirement funds, living annuities are not legally required to adhere to prudent investment guidelines as detailed in Regulation 28 of the Pension Funds Act. However, ASISA strongly recommends that policyholders take these guidelines into consideration when compiling their living annuity portfolios.

Dempsey says according to the survey there has been a significant increase in living annuity policies that do not apply the prudent asset composition guidelines. In 2013, just less than one quarter of living annuity policies did not apply the prudential investment guidelines compared to 18.6% of all policies in 2012.

In terms of the prudential guidelines, exposure to the various asset classes should not exceed the following:
• equity investments – 75%
• non-government debt instruments – 50%
• offshore investments – 25%
• property investments – 25%
• hedge funds, private equity funds and any other asset not specifically mentioned – 15%
• commodities like gold – 10%

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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