Living annuities face a credibility crisis as the consequences of three years of market weakness and volatility hit home.
The early alert on a looming stress test for this popular method of assuring retirement income has been sounded by Imara Asset Management, a fund manager and financial planner with a growing presence in the retirement planning market.
Lara Warburton, managing director of Imara Asset Management SA, says living annuities were never the retirement income panacea for every consumer, but over the past five years there had been substantial product take-up across a broad range of clients.
Living annuities are flexible options with underlying investment in a range of assets, often biased toward equity unit trusts. Clients decide how the money is invested and the income they need. The danger is that too much will be taken too soon, depleting capital and reducing earning power.
Draw-downs like this defer the day when clients face the reality that the remaining sum is woefully inadequate. The longer the dread day is deferred, the bigger the impact and resultant financial distress.
Crunch-time is imminent for some, warns Warburton, a financial planner who already finds herself responding to ‘cries for help’ from living annuity buyers that have endured a painful reality-check.
“The gulf between pre-financial crisis assumptions and post-crisis realities is often to blame,” says Warburton. “In 2006, markets were strong and the financial service industry had become used to high returns.
“Post-meltdown, experts suddenly say we must all get used to low returns and high volatility. Unfortunately, many living annuity pensioners were not contacted and advised to radically adjust his or her strategy. A supposedly prudent drawdown level suddenly becomes an inflated and short-sighted erosion of capital if the rand value of the draw is not adjusted each year to the prudent income percentage.
“Key assumptions in the living annuity market are that buyers are knowledgeable enough to work things out for themselves or will receive continued advice. When both assumptions are flawed, you have a recipe for financial distress.”
She says key factors include:
· A relationship breakdown between client and adviser after the adviser recommended a diversified portfolio of unit trusts – a mix requiring regular attention when markets shift;
· A slow reaction by living annuity holders who had been placed in high-risk specialist funds that lost lots of money in the downturn;
· A shock discovery by some that ‘prudent’ offshore diversification had compounded losses and impacted income potential because of the contraction of developed economies and currency movements;
· Failure to reduce draw-downs in line with new realities.
Warburton notes: “Many pensioners are not aware that up to 20% of the value of the underlying investment value is being drawn as annual income. In a low-growth environment, this means capital is quickly depleted to the point where the pension cannot fund the annuitant’s lifestyle.
“Living annuities are not the best option for everyone and need to be carefully managed with the help of a qualified adviser. Perhaps some traditional pension products are better or a revised mix of options is required.
“Don’t put your head in the sand. If you’re worried about retirement provision via your living annuity, don’t delay. Seek advice from qualified professionals. Every delay compounds the problem.”