Range of living annuity outcomes supports hands-on financial advice through retirement

Back in his mid-20s, your writer ran into some financial difficulties, forcing him to liquidate a small portfolio of unit trusts to make ends meet. Almost three decades later, the regret he feels does not centre on the forced sale of these investments but rather on failing to reinstate a disciplined monthly savings regime. This experience sparked all manner of poor money-related decision making over the ensuing years.

An awesome nest-egg, not

It is tempting to take an arms-length approach to finance and savings. In this case, your writer abandoned discretionary savings in favour of retirement annuities, figuring that by throwing double-digit percentages of his annual gross salary at a couple of asset managers and insurers, he would ensure an awesome retirement nest egg. Wind the clock forward to age 50 and things look less certain. Enter regret, and that oft-repeated ‘if only I had’ refrain. A triplet of truth emerged over this time.

First, you cannot dwell on your financial mistakes. Second, you need discretionary investments to supplement formal retirement savings if you hope to build enough capital for a semi-decent retirement. And third, you can never take your eye off the ball when it comes to the life-long game of savings and investment, especially for multi-decade retirement goals. The trigger for today’s financial reflections was a media release distributed by the Actuarial Society of South Africa (ASSA) under the sombre title: ‘Living annuities require dynamic management to preserve your capital’.

The point being illustrated is that even in the apparent security of a post-retirement living annuity structure, you need to take some responsibility for your financial outcomes. Andrew Davison , chairman of the ASSA’s Investments Committee, held that when you buy a living annuity, you sign up for a difficult balancing act of spending your money just fast enough to enjoy a decent standard of living while ensuring that your capital expires before you do. He contended that you, with or without help from your financial planner, cannot achieve this balance by simply opting for low drawdown rates and hoping for the best.

You cannot set-and-forget your pension

“A living annuity is not a set-and-forget product; its management needs to be dynamic [given that] drawdown rates and investment strategies need tweaking over time [and] taking into account the age, gender, and circumstances of the pensioner and their spouse as well as the economic environment,” Davison said.

And the very nature of the living annuity product contraindicates a ‘sit on the side-lines’ approach. As ASSA pointed out, these products allow you to choose the investment portfolios into which your retirement money is invested, and through that choice, have significant influence on important outcomes like capital preservation and annual income.

At this point, your writer defers to the actuarial society’s number-crunching mastery to expand the topic. Keen to offer tangible examples to illustrate the challenges in managing living annuities, Davison recreated the living annuity outcomes for 75 hypothetical pensioners.

He used identical strategies over a range of market conditions to determine the impact of market returns and the fluctuations of those returns on living annuity outcomes. Similarities in the test included a 30-year retirement horizon and R1?million starting capital; variances arose from the timing of retirement, with the first retiring in January 1957 and another retiring every six months thereafter.

Other important similarities across the 75-person test included the same income drawdown rate starting at 5.7% and increasing by inflation every year and comparable diversified investment strategies within each underlying investment portfolio.

As a side note, since global asset class data only kicked in in 1990, Davison opted for 100% exposure to domestic South African asset classes prior to that date, split across SA Equities (50%); SA Bonds (30%) and SA Cash (20%). Post-1990, each asset class was further split into a local and offshore component with Equities (30% local, 20% offshore); Bonds (20% local, 10% offshore) and Cash (20% local only).

A mic drop moment for living annuity outcomes

The ensuing analysis used actual returns for each asset class and actual consumer price inflation (CPI) with annual fees of 1%. The caveat, important in the context, was that “returns and fees will vary considerably in real life depending on individual circumstances.”

Having set the scene, we can finally dive into the findings of this interesting exercise. According to ASSA, Davison determined that the impact of the fluctuating market conditions on underlying investment portfolios resulted in 32 out of the 75 living annuities running out of capital within the 30-year period. In the world of on-stage presentations, this revelation would be considered a mic drop moment.

This is a high failure rate; if the pensioners concerned happened to have lived a long time, there was a high probability that they were left destitute unless they had other sources of income

Davison's above point nicely underpins the second revelation in your writer’s earlier triplet of truths. And it gets worse. The study showed that the capital in nine of the 75 living annuities had been depleted after just 20 years, with around half of the living annuities left with less than 50% of their original capital, in real terms, at that point. The earliest depleted case was recorded after only 13 years.

Feeling concerned? You should be. If the above paragraph did not prompt an urgent call to your financial adviser or planner, then something might be seriously wrong with your savings and investing outlook. The media release shared one of those over-busy graphs that analysts so love, tracking time in retirement and capital for 75 individuals. The result?

An explosion in a paint factory, with lines crisscrossing in every direction; a chaotic dance; or a technicolour fungus sprouting wildly in all directions. Amid this riot of colour, a thread of sanity prevails: the extreme range of outcomes is staggering given the consistent drawdown and investment approaches.

Slurping up that spaghetti line graph

“The assumed drawdown of 5.7% at the start, with CPI increases each year, is the level that ensures that the capital lasts for precisely 30 years using the average return from the assumed investment strategy,” Davison said, before acknowledging the spaghetti-line nature of his graph.

He argued that the outcomes from this study – which illustrated a wide range of outcomes despite sensible drawdown rates and diversified, balanced investment strategies – made the case for regular re-assessments of both the investment portfolio and the drawdown rate.

“If the timing of your retirement places you on a less-than-favourable investment path, you want to recognise it and do something about it before it is too late,” Davison said. “The unknown of how long you might live and hence the risk of depleting your assets prematurely means that living annuities need careful management and a prudent approach to the level of income withdrawn as a monthly pension.”

It is, therefore, important for financial advice professionals to onboard this conclusion and up the frequency of their client interactions, especially for clients who are on the living annuity journey. It is somewhat ironic that many shy away from getting involved in the rewarding career of financial advising given the countless opportunities for consumer engagement.

The Association for Savings & Investment South Africa (ASISA) living annuity stats, published in November last year, support that thousands of pensioners need financial advice deep into their golden years. And the pending two-pots system, kicking off from 1 September 2024, creates untold opportunities to reach out to those in formal retirement funds, especially as they near retirement age.

It seems SA’s ‘oldies’ are doing ok

To close with some good news, Davison dived into the ASISA stats to reveal that the proportion of pensioners aged 75 and over in the lowest drawdown band of between 2.5% and 5% was greater than all the younger age bands. The older age group also had the fewest cases drawing above 15% annually. And this trend persists despite the reality that as pensioners get older their expected time horizon reduces, meaning they can afford to increase their percentage drawdown without affecting the sustainability of capital.

There will be some pensioners for whom the bequest motive outweighs their need to fund their own living costs, but this pattern in the data seems to indicate a certain inertia about decisions to change parameters on financial products.

Davison left the door open for financial advisers and planners to reach out to their older clients to discuss sustainable drawdown rates and review the composition of underlying living annuity portfolios. As a parting gift, he offered that given current forecasts, a 65-year-old male should aim for a sustainable drawdown percentage of around 4.5% with a moderate balanced investment strategy, and reassess frequently.