Tough times call for cau­tion

In­vestors and re­tirees need to be pru­dent when set­ting their draw-down lev­els, es­pe­cially in a low-re­turns en­vi­ron­ment

Financial Mail - - SPECIAL REPORT -

Liv­ing an­nu­ities can be ef­fec­tive ve­hi­cles for fund­ing re­tire­ment but they re­quire in­vestors to be knowl­edge­able about the way these an­nu­ities work and re­tirees need to be pru­dent when set­ting their draw-down lev­els, par­tic­u­larly in a low-re­turns en­vi­ron­ment.

Pro­fes­sional Prov­i­dent So­ci­ety (PPS) In­vest­ments ex­ec­u­tive: prod­uct de­vel­op­ment Hugo Mal­herbe says un­for­tu­nately South Africans us­ing liv­ing an­nu­ities tend to draw down too much and eat into their re­tire­ment sav­ings cap­i­tal.

In ad­di­tion, the sit­u­a­tion is be­ing wors­ened by the cur­rent tough eco­nomic con­di­tions.

“Mar­kets are volatile at the mo­ment and peo­ple are also start­ing to feel the im­pact of in­creas­ing costs,” Mal­herbe says.

In other words, re­turns are low so there is less money avail­able and peo­ple are tempted to draw down more money to cover ris­ing liv­ing ex­penses.

“There are a lot of ben­e­fits to hav­ing a liv­ing an­nu­ity but you need to un­der­stand the risks as well,” Mal­herbe says.

This is the time when you need to en­sure that you con­tinue to draw a re­spon­si­ble in­come. If you start erod­ing your liv­ing an­nu­ity’s cap­i­tal now, when the mar­kets turn there will be no more cap­i­tal to grow to sup­port your in­come in the fu­ture.

“By draw­ing less you will have more cap­i­tal when mar­kets start go­ing in the right di­rec­tion.”

He says it is im­por­tant that peo­ple think­ing about ac­quir­ing a liv­ing an­nu­ity un­der­stand that when the hard times hit they have to be con­ser­va­tive.

In ad­di­tion, when mar­kets are do­ing well, peo­ple need to con­trol their draw­downs so that their cap­i­tal has a chance to grow.

“Those peo­ple who were re­spon­si­ble dur­ing good mar­ket con­di­tions are now able to take a bit more be­cause they built up more cap­i­tal than they are us­ing to help them through the dif­fi­cult times.

“Their cur­rent po­si­tion should not be a sur­prise, it should be a part of a plan and it should have been dis­cussed with their fi­nan­cial ad­viser,” Mal­herbe says..

“With a liv­ing an­nu­ity you are look­ing at a 20-30 year in­vest­ment hori­zon and dur­ing that time you will go through var­i­ous mar­ket cy­cles, and you need to plan for each of those cy­cles.”

An­other as­pect is that when the liv­ing an­nu­ity kicks off it is a good idea to keep draw­downs to the min­i­mum so that it has an op­por­tu­nity to build up earn­ings to fund such draw­downs.

“The less you use now, the more you have in the fu­ture and this makes a sig­nif­i­cant dif­fer­ence in later years.

“In the­ory you want to be draw­ing less than your real re­turns (tak­ing in­fla­tion into ac­count) and if you are do­ing this in a re­spon­si­ble way, you will not be eat­ing into your cap­i­tal,” Mal­herbe says.

He says the cur­rent sit­u­a­tion em­pha­sises the im­por­tance of sav­ing enough while peo­ple are work­ing to en­sure they ac­cu­mu­late a suf­fi­ciently large pool of cap­i­tal so that it will sup­port them in re­tire­ment, even dur­ing tougher eco­nomic con­di­tions.

More­over, as peo­ple ap­proach re­tire­ment it is a good idea to start ad­just­ing their life­style ex­penses be­fore they re­tire so that they have time to get used to their new bud­get.

“It also gives you a chance to find out if you can live on that

in­come and whether you can af­ford to re­tire or if you may need to work for a cou­ple more years to build more cap­i­tal and give com­pound growth more time to work for you,” Mal­herbe says.

He says when peo­ple have prob­lems after they have re­tired it would be in their best in­ter­est to con­sult with a good fi­nan­cial ad­viser as the ad­viser may be able to help set up proper bud­gets, pri­ori­tise ex­penses and coach them through the ad­just­ment.

Turn­ing to gov­ern­ment’s con­tin­u­ing re­tire­ment sav­ings re­form, he says there are new reg­u­la­tions with re­gard to funds pro­vid­ing de­fault op­tions.

Re­tirees are not forced into the of­fer­ing, and it is just there so that when peo­ple re­tire, and they are un­cer­tain which way to go, the trustees will have a sug­gested of­fer­ing al­ready in place for them.

“It pro­tects them from mak­ing a bad de­ci­sion if they are un­sure and it pro­vides them with a point of com­par­i­son to other op­tions.

“Liv­ing an­nu­ities have been al­lowed as a de­fault strat­egy and this will have to in­clude a de­fault draw­down op­tion as guid­ance for mem­bers.

“The reg­u­la­tions have been pub­lished by the reg­u­la­tor and it is in ef­fect im­me­di­ately for funds that are al­ready pro­vid­ing de­fault op­tions and those that are not do­ing so at the mo­ment will have to do so from the be­gin­ning of March, 2019,” Mal­herbe says.

Corona­tion Fund Man­agers head of per­sonal in­vest­ments Pi­eter Koeke­moer says liv­ing an­nu­ities are ex­cel­lent re­tire­ment fund­ing ve­hi­cles but they re­quire proper man­age­ment to make them work.

“While you are tak­ing on some risk, if you take that risk in a con­sid­ered way, most of the time you should end up be­ing slightly bet­ter off than you would be with the al­ter­na­tive route of an un­der­writ­ten an­nu­ity.

“You take less risk with an un­der­writ­ten or guar­an­teed an­nu­ity but you also have more lim­ited up­side,” Koeke­moer says.

He says the ma­jor risk as­so­ci­ated with a liv­ing an­nu­ity is run­ning out of money too quickly and hav­ing a drop in liv­ing stan­dards as a con­se­quence.

“What you need to get right with a liv­ing an­nu­ity is a com­bi­na­tion of longevity, in­fla­tion and se­quence of re­turns risk.

“If you end up tak­ing too much too quickly and you end up liv­ing longer you have a de­cline in your liv­ing stan­dards.

“How­ever, you can­not in­vest too con­ser­va­tively or in­fla­tion will erode your spend­ing power.

“At the same time, you can­not take on too much risk be­cause of the se­quence of re­turns is­sue.

“This has a lot to do with the or­der in which you are earn­ing your re­turns. As you are draw­ing an in­come it is less than ideal to have a bad in­vest­ment re­turn pe­riod at the start of re­tire­ment.

“The only way to pro­tect your­self from this is to start off with a fairly con­ser­va­tive in­come draw­down rate and wait­ing for re­turns to come through be­fore you in­crease your spend­ing out of the port­fo­lio,” Koeke­moer says.

Hugo Mal­herbe: Avoid temp­ta­tion to draw down more to cover ris­ing costs

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