The great living annuity balancing act: Income today versus security tomorrow

So, you’re fortunate enough to be one of the small percentage of South Africans to end your career with a decent retirement nest egg. Your worries are over, right? You can spend the rest of your life enjoying your hobbies, friends, and family in the ways you’ve dreamed of for the past forty or so years. And you might well think that because you’ve looked at your savings and answered the question, “how much income can my savings provide today?” with “enough”.

But there’s a much bigger question you should ask yourself: How do I ensure that this income lasts as long as I do? After all, a generation or so ago, most people could reasonably expect their retirement to last around a decade. Today, retirement can last 20 or even 30 years. That, in turn, means that chasing the highest possible initial payout may end up jeopardising your long-term financial security.

That begs the question: what is the best approach to using your retirement savings? While there’s no universal answer to that question, there are three interconnected decisions that can help put you on the path to retirement success. Those decisions involve choosing the right vehicle (living, guaranteed, or hybrid annuity), getting the underlying asset allocation right, and managing silent wealth killers, such as fees and tax inefficiency.

Demystifying the living annuity (the engine vs the fuel)

For those unfamiliar with the term, a living annuity differs from a traditional guaranteed annuity in one important way: a living annuity keeps your capital invested in the markets while giving you a regular income. A guaranteed annuity, on the other hand, pays you a fixed amount until you pass away. Finally, a hybrid annuity is a blend of the two.

Now, you may have been told that a living annuity is simply a tax-wrapped legal vehicle rather than an investment product on its own. That’s not entirely the full picture. Instead, it allows people to meet their statutory income drawdowns between 2.5% and 17.5% while still growing their wealth.

The feeling that living annuities are legal vehicles may come from cases where the living annuity underperforms. In those instances, investors often blame the annuity structure itself. In reality, there are usually other culprits at play, including an inappropriate underlying investment portfolio, an aggressive drawdown rate, or high layers of fees.

On sustainable drawdowns

The middle of those factors is especially important, given that it’s the one investors have the most control over. While a five or six percent drawdown, for example, might seem conservative today, inflation and withdrawals can compound over time, especially if the market stalls during your retirement. Suddenly, you may find that inflation has eaten into your capital and you’re having to draw down more than you’d like in later years. This can leave retirees facing difficult financial choices later in life, potentially compromising the independence and lifestyle they had hoped to maintain throughout their retirement years".

Avoiding getting to this tipping point means matching your drawdown rates with realistic portfolio growth expectations. While there is a degree of individualisation in this process, the Association for Savings and Investment South Africa (ASISA)’s Living Annuity Standard and Guidelines do offer a useful guide.

Living annuity vs guaranteed annuity: a false choice?

Knowing the above, it might be tempting to go all-in on a living annuity. It’s important to know, however, that doing so comes with tradeoffs. So, while a living annuity offers flexibility, capital preservation, and estate planning benefits, it also leaves the investor carrying the longevity and market risk.

That’s not to say that guaranteed annuities don’t come with their own set of benefits and complications either. It eliminates the longevity risk by guaranteeing an income for life, but means sacrificing capital flexibility and legacy benefits.

A potential solution is to combine the two structures. This can be done either through a single blended annuity or a hybrid annuity strategy. A blended annuity is an all-in-one product, where a guaranteed life annuity is wrapped up as an asset class or portfolio inside your living annuity wrapper. A hybrid approach, meanwhile, entails holding separate guaranteed life and living annuities.

Both options allow you to use your guaranteed life annuity to cover fixed, essential monthly expenses, such as medical aid and utilities, providing income security and peace of mind. Your living annuity, meanwhile, stays actively invested in the markets, allowing you to continue growing your capital and hedging against inflation. It also preserves capital flexibility, which is important in case of high-cost emergencies, and estate legacy planning benefits for your beneficiaries.

In food terms, you can think of a blended annuity as a smoothie, where the protein you need to keep growing muscle (the living annuity) is mixed in with the carbohydrates, fibre, and other nutrients you need to get you through the day (the guaranteed life annuity). A hybrid annuity, meanwhile, is more like having steak, potatoes, and vegetables on your dinner plate. Either way, you’re still getting the “nutrients” you need to achieve the financial stability needed to survive market volatility alongside the growth potential required to sustain a 20- or 30-year retirement.

Don’t underestimate the impact of fees

Regardless of the retirement vehicle, or vehicles, you have, it’s critical to manage costs as stringently as possible, especially once you start drawing down. A good place to start on this front is to look at the total costs of your retirement investments.

How much are you paying in investment, management, and advice fees, for instance? Are those fees comparable to what other retirees are paying on a like-for-like basis?

If not, press for lower fees. Even something as small as a one percent difference can compound over a 25-year retirement. That, in turn, can translate into hundreds of thousands of rands stripped directly from your retirement income stream.

Playing the long game: strategy over structure

Once you’re confident that you’ve got your costs where they should be, it’s important to remember that retirement is (hopefully) a long game, even when you’re in it. With time on your hands, it might be tempting to be a little more active with your investments.

That’s even more tempting during a period of general volatility, but making knee-jerk shifts to your portfolio based on news headlines is a bad idea, no matter when you do it. Not least because doing so can lock in paper losses permanently. Patience still matters, even when you feel like you don’t have a lot of time left for it.

Ultimately, no matter which stage of life you’re at, successful retirement planning isn’t about chasing a high starting yield or finding a “magic bullet” product. It’s about being engaged in an ongoing, holistic balancing act that combines flexible income management, cost control, and inflation protection. This will help ensure that you end up with, and can sustain, a financial legacy that you and your loved ones can be proud of.