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Less is more when it comes to living annuity draw downs

25 July 2011 Gareth Stokes
Gareth Stokes, FAnews Online Editor

Gareth Stokes, FAnews Online Editor

I’ve covered the ‘save for retirement’ topic on a number of occasions. The experts say you will retire comfortably provided you tuck away 15% of your gross salary over a period of 30-years, earn market-related returns on your retirement savings, and alway

The topic less frequently covered by the media is how to manage your retirement nest egg upon retirement. At retirement the law allows you to draw down (subject to the taxation regime of the time) one third of the accumulated capital in your pension fund or retirement annuity (or 100% of the amount in your provident fund). The remaining two thirds must be used to purchase an annuity, a financial instrument designed to provide income through your retirement years. The country’s major life insurers and fund managers offer a range of annuity products, including traditional annuities, guaranteed annuities and living annuities. In today’s newsletter we’ll take a closer look at the living annuity as discussed in an article by Lourens Coetzee, an investment professional at Marriott Asset Management.

The capital preservation versus income dilemma

If you purchase a living annuity you have to draw a regular income of between 2.5% and 17.5% of your annual investment value, reviewed each year. Unlike ordinary annuities, where the balance at death passes to the insurer, any final value on the living annuity is paid to your beneficiaries. But there are risks associated with this type of annuity. Because living annuities rely on investment return to provide income in retirement, life insurers suggest you only select the product if you have other sources of retirement funding. It is also critical that you make use of a professional financial adviser to assist you with the asset allocation and draw down choices associated with the product!

“Retired investors commonly face the dilemma of either maintaining a certain lifestyle or lowering it in order to preserve their capital for longer,” writes Coetzee. One of the most critical choices at retirement is how much income you draw from your living annuity. The more you draw the less capital is available to create future income! “If you opt for too much income now, you risk eroding your capital over time and possibly even wiping it out,” he says. A sensible choice is to draw down as little as possible of your capital each year to preserve your investment value for as long as possible.

“Capital preservation is dependent on two variables: the performance of the underlying assets (capital and income returns), and the extent to which income is drawn from the annuity,” says Coetzee. The retiree, with assistance from a financial planner, has some control over these variables. You can influence performance by making sure the underlying assets in your living annuity are appropriately weighted (according to your life stage / risk profile) to equities, bonds and listed property. And choosing the lowest possible draw down takes care of the latter.

Does your living annuity make the grade?

How do you maximise your investment return through retirement? According to Marriott Asset Management the average annual real return on asset classes, going back four decades, is 10.71% for equities, 2.45% for bonds and 2.24% for cash. And the average balanced fund is invested approximately 60% in equities, 30% in bonds and 10% in cash. To investigate the effect of different capital draw downs on living annuities Marriott considered 30-year rolling period performances for an average balanced fund going back to 1900. This gives them 81 periods to assess. Their other assumptions include an all-in fee of 2.3% per annum (the current approximate market fee for living annuities) and using the previous year’s inflation rate to determine annual income escalations.

The findings will probably shock a number of retirees who believe they are drawing down an acceptable capital amount from their living annuities. Marriott’s calculations show that only five in every 100 retirees drawing down 7% of their living annuity capital would have been able to sustain their income through retirement. And only 15% of these individuals would still have capital at death. The picture is only slightly healthier if a draw down of 5% is selected. In this scenario 38% of retirees would be able to sustain their income through retirement, with capital lasting in around half of all case. The best outcome was achieved with a draw down of only 3%! This prudent approach would see 91% of retirees retaining income, with capital ‘outlasting’ the retiree 99% of the time. “The results since 1960 (during which there are 18 rolling 30-year periods) were similar,” says Coetzee, although slightly better real returns from equities over these periods led to improved result for persons drawing 5% of their capital each year.

You may have to restrict your annuity income

Financial planning through retirement is complicated by uncertain life expectancies. At age 65 it is impossible to know for how long your retirement capital needs to provide an income. “We urge retirees to examine their situation carefully when contemplating using their capital to supplement income – and suggest they preserve capital until they reach a stage in their retirement years when it may become safe to reduce it,” writes Coetzee.

To this end annuity providers offer differently structured products. Marriott offers an investment-linked living annuity (the Perpetual Annuity) that invests in three underlying Marriott funds of funds and is structured to enable investors to draw the level of income that their underlying funds produce, thus ensuring that their capital is preserved. Retirees, with assistance from their financial planners, can use the company’s online Living Annuity Tool to set an annuity at a level which ensures that it matches the income from the underlying investments!

“While investors may find it challenging to restrict their annuity income to the income produced by their investment choice, it is preferable to finding that one’s capital has been completely (or even partially) eroded,” concludes Coetzee. “Rather be conservative now, than risk having to find another source of income or having to reduce one’s standard of living at some point in the future.”

Editor’s thoughts: Each of South Africa’s major life insurers offers a variety of annuity-type products. The advice offered by professional financial advisers is critical in assisting retirees in making the correct annuity decision. Which annuity product do you favour? And do you lean towards living annuities when advising your clients at retirement? Please add your comment below, or send it to


Added by Fox Mulder, 03 Jun 2012
Interesting. Each person's inflation differs. One has to have a survivalist mindset in this day and age. Fact. Besides being in a lifestage annuity one should also be into physical Gold and Silver at approx 10 to 20% of your life savings value! Further to that I would suggest that folks also consider quality numismatic coins. Its interesting and Bid or Buy online is the best place to start on the internet. Just browse first and follow the market. SA Mint proofs, the older ZAR coins and the famous Nelson Mandela mint state and proof coins are certainly worth considering. Going back to paper money based lifestage annuities I would suggest folks running the whole process on their own Excel spreadsheets. Its nice to follow the graphical projections comparatively with your daily actual annuity performance. A good ROI v capital retention/mileage v drawdown is quite a challenge - but doable and should become easier over time. Gold should peak around 2019. Then sell PM's and and buy stocks. Much the same scenario as was the case in 1979! 1999 was the time to have bought Gold/Silver. The PM cycles can be followed over their 20 year boom bust periods. Just imagine the following: Take say a R1000,000 ok. Now divide that by R5000 and you have 200. Now divide that by 12 and you have nearly 17 years income. That is besides any interest or any annuity setup. Right now look at this next scenario! Take R1000,000 and divide by say R8000 and you have 125. Now divide by 12 and you have nearly 10.5 years. Yet try and do that with an annuity and you cannot do so because of the 17.5% drawdown ceiling. Annuities are fine in lifestage form but are generally not cheap. So one needs additional tangible third party free investments/assets in my opinion.
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Added by Hentie, 25 Jul 2011
Easier said than done as most of the clients don't want to lower their standard of living after retirement and very few have sufficient funds at retirement to ensure capital growth in their living annuities during the first 10 years after retirement. The financial planner has, most of the time, no option as to be more aggressive in his/her proposal than the risk profile of the client. My personal view is that too much emphasize is laid on the risk profile rather than on the income required in proportion to the funds available and this fact should determine what the asset allocation should be.
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Added by Rory, 25 Jul 2011
Articles such as this are all well and good but fail (as does those of Cameron) to highlight two important and fundamental issues : (1) Comparative Annuity rates offered for 'conventional' compulsory purchase annuities. The annuity rate offered to a 60year old married with a statistically younger spouse is pathetic. Taking any sort of extra (such as minimum payment guarantee periods, joint life or heaven forbid an income escalation) sees the resultant initial annuity plummet to unsustainable minimum entry income levels for many retirees. In my experience it also takes at least 13 years to simply recoup your original capital outlay - by which time many have already passed on. Great investment. (2) The concept that capital should be preserved until death in terms of a living annuity should also be unpacked. Sure a younger spouse and unexpected longevity are issues that must be addressed but an unnatural focus on capital preservation in the interests of supposed 'sustainability' can also lead to undesirable results. Capital should be expected to be gradually exhausted over the post retirement period and this is where skilled intervention is required. The horror stories emanating from financial journalists around living annuities fail to be balanced by the stories of misery generated by opaque fixed income conventional annuities where mortality profits no doubt form a significant component of life assurer proceeds. In my opinion conventional 'for life' annuity products should also carry health warnings as to the inflexibility of the resultant income and be accompanied by illustrations as to the purchasing power of such traditional annuities with varying age and inflation rates and some idea as to what profits are being made by the assurer concerned.
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