Let’s be frank about retirement
POOR CHOICES: FEW CAN AFFORD TO MAINTAIN LIFESTYLE AFTER WORKING LIFE
There is a crisis.
Only a small percentage of South Africans are able to maintain their standard of living in retirement and roughly 90% of pensioners choose a living annuity (LA). But warnings about greater longevity, unsustainable LA drawdown rates and lower expected returns are still met with criticism.
So let’s be frank. 1. No product can rectify a lifetime of poor choices
Where most South Africans cash out their retirement benefits when changing jobs, fees generally remain high and most funds underperform, the reality is most people don’t have adequate savings to sustain them in retirement.
Armed with only a small savings pot, pensioners often choose an LA as it allows a higher initial income and they can leave the remaining money to beneficiaries at death. LAs offer greater flexibility (you can draw 2.5% to 17.5% of capital p.a.), but the pensioner carries the longevity and investment risk. In guaranteed annuities, the insurer guarantees an income for life, but the initial income level is dependent on the lump sum and current rates.
But no product/vehicle can remedy 20 to 30 years of bad savings behaviour. 2. LAs are great, but not for everyone
A retirement educator argued if someone gets a decent income from a 4% annual drawdown rate, they can afford an LA. If they can’t, they’re probably overspending. Another commentator said in addition to the 4% “safe max rule”, investors shouldn’t be allowed to withdraw more than the portfolio’s actual return before age 68.
That doesn’t mean the vehicle has a design shortcoming, but LAs aren’t appropriate for 90% of retirees.
Unfortunately, there are vested interests. For example, there could be substantial benefits for advisors recommending LAs due to ongoing fees.
On LAs, Investec’s Marc Lindley said someone would generally be set for a relatively comfortable retirement if they could meet their monthly expenses by drawing 5% or less of their capital at retirement.
However, if individuals drew 10% or more, they’d need an alternative solution, which would probably involve relying on family or working longer.
“Fortunately changes in pension fund legislation now … allow people to do that without having to convert the savings they have got into an annuity.”
For people who need to draw 5% to 10%, an LA might be suitable, but Investec suggests they insure part of their longevity risk. Here, hybrid solutions could play a role. 3. What worked in the past may not work in future
People are living longer, putting retirement savings under pressure, and future investment returns are seen lower.
Analytics Consulting’s Bernard van Wyk said a rough estimate of expected returns suggests average general equity fund returns over the next decade (after fees) could be comparable to the net returns of low- and medium equity funds over the past 17 years.
For the best part of the past 20 years, relatively high fees and drawdown rates were concealed by the returns delivered by the local equity market, but this may not be the case going forward.
As such, it would be prudent for retirees invested in LAs to think carefully about their underlying asset allocation and drawdown strategies.
For those en route to retirement, it shows the importance of appropriate savings choices, staying invested and choosing carefully at retirement.