Category Retirement
SUB CATEGORIES General |  Savings & Investments |  Annuties | 

Living annuitants will not leave a legacy unless essential spending is covered

13 November 2017 Deane Moore, Just SA
Deane Moore, CEO of Just.

Deane Moore, CEO of Just.

One of the reasons given for the popularity of living annuities is that, on death, the remaining capital can be left to beneficiaries. Based on analysis by Just, a provider of sustainable income solutions in retirement, it is only the one-third of living annuity investors drawing less than 5% p.a. that have a high probability of leaving some legacy to beneficiaries.

“The harsh reality is that it is unrealistic for retirees who cannot afford to sustain their essential expenditure for life, to contemplate a legacy for beneficiaries,” says Deane Moore, CEO of Just.

A typical retiring couple, a male aged 65 and female aged 61 earning R40 000 per month, will need R7 million of capital at retirement to meet essential post-tax expenditure of R27 000 per month (67% of their income).

“Living annuity policyholders need a solution that ensures they can meet their essential expenditure regardless of how long they or their spouses live. To meet this need, Just has developed a Lifetime Income asset class for living annuities which provides clients with an income for life, targeted to grow with inflation,” says Moore.

The crisis of unsustainable retirement income will become visible in 2020 to 2030

The average life expectancy of people who retire at age 65 is 18 years for a male and 22 years for a female. This is an average, which means that 50% will live longer than this.

Females live longer than males and make up 70% of the population aged 85 or older . The proportion of males and females who can expect to survive into their 90s and beyond is set out in the following table:

“The first living annuity was issued in the early 1990s. Very few living annuity investors have reached their average life expectancy, which is why we have not yet seen the crisis of unsustainable retirement income manifest. The 1990s’ cohort of living annuity investors will start to live beyond their life expectancy in the next decade. It is women who will live longest and bear the brunt of this crisis,” he says.

According to Moore the other factor driving the crisis of unsustainable retirement income is declining investment returns. The following graph shows how investment returns on the Top 40 equity index have trended downwards recently – five-year rolling averages are used to reduce the volatility and show the trend line more clearly.

Investment tools are not sufficient to solve this crisis of unsustainable retirement income

Some innovative investment tools are being developed to help deal with one small aspect of the crisis of unsustainable retirement income, and that is investment return volatility. However, these do not deal with the fundamental issue of sustaining retirement income for life.

Insurance allows a group of people to manage large unpredictable losses for individuals

The crisis of retirement income being insufficient to meet the essential expenditure of a group of individuals is a classic problem which insurance was designed to solve.

Here the focus is on the portion of assets required to sustain each individual’s essential expenditure for life, and not the discretionary assets to cover holidays, gifts and legacy to beneficiaries. At retirement, no one knows whether they will live longer or shorter than expected, but it gives significant peace of mind to know that essential expenditure will be covered regardless of how long they live. It is the perfect situation for sharing risk across a pool – each person puts into the pool the assets required to support essential expenses for their life expectancy, and each person receives their essential expenditure throughout their actual lifetime. Those that live longest benefit from the cross-subsidy of those who die earlier.

“This insurance creates an asset which increases in value the longer a person lives, and this is the only instrument that is appropriate for meeting the requirement of sustaining retirement income for life,” says Moore.

The other benefit of pooling individual risks across a group is that it allows insurance and asset management professionals to select an appropriate asset management strategy and use a company’s balance sheet to smooth out volatility, rather than being limited to attempting this within the constraint of an individual’s resources. An individual in retirement usually has no other source of income to sustain them under adverse conditions, which forces them to be too risk averse and forfeit the value of additional long-term investment returns which they could gain from taking additional investment risk within the context of an insurance safety net.

How to consume more and sustain this for life

Living annuity investors can benefit from thinking about their retirement assets in two portions:

• One that secures a level of lifetime income that will meet their essential expenditure needs for life (food, accommodation, utilities, medical, transport, insurance) and is targeted to grow with inflation;
• The remainder to meet their needs for a rainy day, and for long-term growth for themselves and their beneficiaries, knowing that their essential expenses are covered. Given that their essential expenditure is already covered for life, this allows investors to be more adventurous in pursuing long-term investment returns without changing their overall risk appetite.

Just Lifetime Income is an asset class designed to provide sustainable income for life that meets essential expenditure. It is available within selected living annuities with the following key benefits:

• The investor receives a lifetime income that will never reduce, regardless of what happens to investment markets or how long the client and their spouse live.
• The lifetime income is increased each year at a rate that targets inflation. The increase is linked to the returns of independent asset managers with no insurer discretion, and is smoothed.

Below is an illustration of the initial lifetime income asset class available to living annuity investors that significantly mitigates the risk of running out of assets to cover essential expenditure:

Who would benefit most from Just Lifetime Income?

The following people would benefit from investing in Just Lifetime Income at retirement:

• The typical person or couple at retirement wanting to cover essential expenses for life and invest the balance of their assets to maximise long-term growth
• The living annuity client who is drawing more than 5% and starting to consume capital
• The widow who is seeking to sustain income
• The person who has recently had a severe medical event
• The person who wants to ensure that essential expenses and frail care costs are covered in case dementia strikes
• The healthy and wealthy person looking for a diversifying asset class that increases in value with increased longevity: they can accumulate these lifetime income payments in their living annuity without having to draw them. This provides a very interesting diversifying asset class where part of the return comes from their own longevity.

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