Pensioners not immune to poorly performing global economy

Much has been written about the impact of 2008 and its aftermath on those actively employed and saving for retirement. Not much has however been written about pensioners, especially those who retired in the period when double digit returns were the norm –

Unlike active employees, pensioners don’t have free cash flow. As such, “their only remedy is to reduce expenditure and increase investment. And the only way to do this is to look backwards” says Alan Wood, Head of Institutional Business, Investment Solutions.

Over the decade preceding the financial crisis in 2008, pensioners actually did better than they should have expected, receiving better investment incomes and funding better than expected lifestyles. This provides an opportunity to unlock some of these historical gains for investment.

Or, more simply put, “find the fat in the monthly budget and use it to create future income” says Wood.

A typical retirement fund will follow an investment strategy aimed at growing assets by CPI+ 5% to 6% per annum in a growth investment portfolio. Leading up to 2008 growth portfolios generated phenomenal returns, many in excess of CPI+ 10% per annum. With well diversified balanced portfolios delivering returns of 9% to 10% per annum over the last 5 years, compared with inflation of just under 7% per annum, the picture over the last 5 years has not been so rosy.

“It’s also becoming clear that achieving CPI+ 6% returns over the next 5 years will be difficult and unlikely in a pensioner investment portfolio” says Wood.

For example, if Joe retired at 60 in January 2008 with a healthy credit in his defined contribution retirement fund, selling his house in Bryanston at a good profit before purchasing a cheaper home in Balito, Joe would be amongst the one in ten South Africans to have retired comfortably. Yet even Joe’s income at retirement dropped to about 50% - 75% of what he was earning while he was working. At the time this wasn’t a problem because Joe had banked a healthy profit from the sale of his Bryanston home with which to supplement his monthly income.

Today, almost four years after the financial crisis of 2008, Joe notices that he hasn’t received an increase in the last four years from his with-profit annuity. Joe also dipped into his savings in 2010 to buy a new car. The healthy profit from the sale of his home is now depleted and, for the first time, Joe is faced with living on his real retirement income.

While Joe chose to invest in a with-profit annuity at retirement in 2008, his financial advisor had, in fact, given him three annuity options; a living annuity, with profit annuity or a fixed annuity.

In a living annuity the retiree transfers their retirement fund credit to an insurance company and then draws a monthly income from this investment portfolio for the rest of their lives.

A with profit annuity is similar to the pension that would have been received from a pension fund. Retirees use their fund credit to purchase a guaranteed monthly pension from an insurance company who in turn invests these assets. The retirees’ basic pension is guaranteed, but increases are only granted if the underlying assets deliver an adequate return. The way with profit annuities are structured means that the underlying investments often need to deliver investment performance of CPI+ 5% (or more) to deliver CPI related increases.

A fixed annuity pays a guaranteed fixed amount. While retirees can also purchase a fixed annuity that increases by a pre-determined amount each year, this will reduce the monthly amount retiree’s receive when they retire.

While, certainly, the choice of annuity at retirement is critical to any pensioner’s financial security, “pensioners have witnessed their real income dwindle in recent years” says Wood.

Pensioners who invested in living annuities have had to reduce the amount they draw to live on each month, or face the prospect of running out of money in future. Those who invested in with-profit annuities have not received inflationary increases. Even pensioners who purchased fixed annuities are subject to what is likely to be an increasingly challenging inflation environment over the next decade.

In short, “regardless of the pension package chosen, in an environment of weak returns, inflation is now the silent killer” says Wood.

In this environment, those pensioners who refuse to alter their spending patterns or downscale their lifestyles will drawn down their investments to critically dangerous levels – making growth, and hence the chance of improving or even maintaining their income in an environment of low returns, a near impossibility.

For example, if a living annuity providing R12 000 a month 5 yrs ago now only provides R8000, spending patterns should alter accordingly. Maintaining current spending – by drawing an additional R4000 each month - will only draw down the fund, wiping out any chance for inflation-linked growth in future.

Instead, pensioners, like actively employed people, “need to accept the reality that they did well in the bull market of the last decade – and should now try and unlock some of these gains for future income by adapting their lifestyles” says Wood.