Struggling in retirement at the cost of a legacy

Johann Swanepoel, Product Actuary at Just.

The Associatian of Savings and Investments South Africa (ASISA) recently announced that drawdown rates on living annuities increased from 6.44% to 6.62% in 2016. The increase for the first time in six years since 2011 in drawdown rates is not surprising, given that markets had been relatively flat and inflation still relatively high.

“Currently over 90% of people reaching retirement invests in living annuities and draws on average 6.62% of the capital each year. Retirees had to draw more money from their living annuities to make ends meet. The concern is that as much as one out of two of them run the risk of having to drastically reduce their living standards in future or become a significant financial burden on their families,” says Johann Swanepoel, Product Actuary at Just.

To illustrate the risk to retirees in standard living annuities and how the drawdown rate will increase, Just used an example of someone who retires at 65 and start by drawing 6.5% per year. Assume inflation is 6% per year and the investment delivers CPI+3% per year after fees. The retiree’s income has to keep up with inflation and therefore needs to increase with 6% each year. Over time the drawdown percentage will increase as seen in the table below:

The drawdown percentage increases as the retirees start to consume their capital and by age 81 it reaches the maximum limit of 17.5%.It is expected that 50% of people retiring at the age of 65 will live past the age of 81, so half of the retired population is expected to reach the legal maximum drawdown of 17,5% if they adjust their income with inflation. The only way pensioners can avoid this from happening is if they earn higher investment returns or if they consume less by reducing their standard of living for longer,” says Swanepoel.

Once you reach this limit, it means your investments need to earn a staggering 23% per year after fees for your income to still increase with inflation to cover your basic living expenses. If your assets cannot deliver that return, your income will reduce i.e. your income will not keep up with inflation and it will reduce in rand terms.

“Few people understand that the legal drawdown limit of 17,5% is the main reason why retirees will end up leaving something for beneficiaries. It is estimated that the average retiree invested in a standard living annuity will leave an inheritance of 20 – 25% of their original savings because they cannot draw the remaining capital due to the limit drawdown of 17,5%,” reflects Swanepoel.

In 2016 returns on investments for the last three years were between 5 – 7%. The JSE All Share Index delivered only 2.6% with inflation at 6.6% for 2016. So to expect returns of 23% just to cover living expenses is just not viable in current markets. The 17.5% cap will prevent many retirees in their later years to maintain their standard of living.

“The money is there, but you cannot draw more, even when you desperately need it. This is how the average living annuity retiree will end up leaving an inheritance. Not financially independent, but in desperate need of support where the retiree is struggling to cover basic expenses. At best it is just giving back some of the money your children had to fork out to support you. Relying on a living annuity to leave a legacy could come at the expense of your ability to maintain your living standard and financial independence. It may be better to consider taking out separate life cover if you are serious about leaving something behind and to ensure that by doing so will not have a negative affect on your standard of living in later years,” suggests Swanepoel.

“We believe there is a space for both living and guaranteed annuities and that it is no longer a choice of either/or. Just has developed an innovative way in which to combine the best features of both retirement options to help you cover your basic living expenses while still having flexibility with your discretionary income. It is best when reaching retirement to sit with a financial adviser who will be able to help you choose the right options for your circumstances,” concludes Swanepoel.