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SUB CATEGORIES General |  Savings & Investments |  Annuties | 

Flexible drawdowns on living annuity income could see South Africans outlive their savings

06 July 2015 Youri Dolya, Alexander Forbes

The day working people retire they need to consider their investment options carefully to ensure their retirement savings will work for them well into the future. This is the advice from Alexander Forbes Financial Services Retail Best Practice Leader Youri Dolya.

A Living Annuity provides the investor with an income from retirement savings, with flexibility to decide how to invest this money as well as choose how much they draw from it each year (by law between 2.5% and 17.5% if a policy was bought after 21 February 2007).

However, in exchange for this flexibility, Dolya cautions that investors carry the risk of outliving their savings – and also risk possible poor investment returns if they do not get sound financial advice. “This means that your future income could fail to keep up with inflation, but the worst case scenario would be outliving your savings.”

Dolya indicates that a living annuity would suit retirees with more than R1.5-million in accumulated retirement savings, who were in good health and did not wish to be “locked in” an investment vehicle. “This type of annuity can also be a valuable tool to protect against inflation, if policyholders take proper, professional advice on where to invest,” he said.

“A living annuity is used by retirees as the most popular choice of portioning off their savings, but it’s essential to get the correct advice as it is the most complex of all annuities. The approach we have is to look at what your income for necessities versus comfort is. We have to balance the capital you have relative to your income requirements over time, and work out what a sustainable draw rate is – this needs to be reviewed annually.”

According to the 2014 Living Annuities Survey released in June by the Association for Savings and Investment South Africa, living annuity policyholders withdrew on average 6.59% of their capital as income in 2014, which represents only a marginal decrease from the 6.63% drawdown level in 2013.

“Drawing too much from your living annuity goes against the fundamental premise of what your pension needs to do for you, which is to be sustainable. If you go in with a low capital amount to begin with and start drawing too much, sustainability is severely compromised.”

“An optimal draw strategy is to draw as little as possible annually. However, as policyholders have so much leeway, many elect high drawdown rates and end up eroding their capital, leaving themselves with no safety net.”

Dolya said people drawing more than 10% of their capital were on a downward slope. “This is where we would suggest changing to a different type of investment, such as a life annuity. The type of life annuity that can be taken would depend on the amount remaining in the living annuity account at that stage. Ideally, we would seek to choose an annuity that keeps pace with inflation.”

This type of strategy of initially taking out a living annuity and subsequently converting to a life annuity is commonly referred to as delayed Annuitisation. “This strategy provides an effective means through which an individual can have flexibility early on in their retirement and subsequently address longevity and investment risks by converting to a life annuity,” said Dolya.

“Another main attractor of a living annuity is the ability to leave any remaining money to beneficiaries upon your death. However, this option should be weighed up against the longevity and investment risks that are assumed by the pensioner.”

“In line with the National Treasury’s proposed retirement reforms, government wants the annuities market to be structured in a way which encourages members of retirement funds to make good choices at retirement. Choosing the right annuity depends on an array of factors - it therefore becomes crucial that individuals make this decision with the right advice and information in hand.”

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