When you buy a living annuity, you sign up for a difficult balancing act – spending your money just fast enough to enjoy a decent standard of living but not so fast that your capital expires before you do, according to Andrew Davison, chairman of the Investments Committee of the Actuarial Society of South Africa (ASSA).
Davison says this cannot be achieved by simply opting for low drawdown rates and then hoping for the best.
“A living annuity is not a set-and-forget product,” he adds. “The management of a living annuity needs to be dynamic. Drawdown rates and investment strategies may need tweaking over time, taking into account the age, gender and circumstances of the pensioner and their spouse as well as the economic environment.”
Living annuities are also referred to as investment-linked living annuities because they allow you to choose the investment portfolios into which your retirement money is invested. Because you can choose the underlying investments, a living annuity does not guarantee a regular income or the preservation of your retirement capital.
To highlight the challenges involved in managing living annuities, Davison recreated the outcomes of living annuities for 75 hypothetical pensioners.
The assumptions
Davison’s objective was to compare identical strategies applied during different market conditions to understand the impact of market returns and the fluctuations of those returns on outcomes. Assumptions were the same for all 75 living annuities, except that the pensioners retired on different dates. The first retired in January 1957, with another retiring every six months thereafter until 1994, allowing for a 30-year period until the end of 2023. All 75 pensioners had a retirement horizon of 30 years and bought their living annuity with a retirement capital of R1 million.
The 75 pensioners had the same income strategy of drawing an income of 5.7% at the start, increasing by inflation every year. Living annuities allow clients to select an income level between 2.5% and 17.5% annually.
The pensioners were also assumed to have applied comparable, diversified investment strategies to the underlying investment portfolios. Davison’s dataset for global asset classes began in 1990, so the investment strategy assumed before that was 100% exposure to domestic South African asset classes. However, the overall allocation to equities, bonds and cash was consistent throughout.
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