Retirement to become riskier
CRISIS AHEAD: SOME RETIREES COULD BE DESTITUTE
Investors should adjust to a lower-return environment.
There have been growing concerns that retirees haven’t adjusted to a lower-return environment. In fact, some industry commentators believe a crisis may appear within the next decade.
According to the Association for Savings and Investment South Africa’s (Asisa) 2017 Living Annuity Survey, the average living annuity (LA) drawdown rate remained almost unchanged from a year before at 6.64% (2016: 6.62%).
Legislation allows retirees to draw between 2.5% and 17.5% from LAs per annum, but the pensioner bears the risk (that investment returns won’t be enough to compensate for drawdowns) and the longevity risk (that the money will dry up before he dies).
So what can be deduced from the Asisa average in isolation? Not a lot, unfortunately.
Craig Gradidge at Gradidge-Mahura Investments says the average would be skewed by people with bigger LAs, who tend to have lower drawdowns, while those with smaller annuities generally have bigger drawdowns. So the average may hide more than it reveals.
Asisa’s Taryn Hirsch says the problem with LAs is that the industry doesn’t know underlying annuitants’ personal circumstances: whether it’s their only annuity or if they have other assets to supplement their annuity income. Some individuals may still be earning an income in retirement and drawing a high percentage from a small annuity, intending to deplete it as soon as possible.
As such, it’s very difficult to get a clear sense of the percentage of LA policyholders who risk running out of money in retirement.
Pensioners choosing these products must examine their unique circumstances. Drawdown rates, asset allocation and annual increases are key inputs retirees can manage, whereas inflation, longevity and market returns are out of their control.
Over the last three years, the average multi-asset medium equity fund delivered 5.8% before advice and administration fees, so the average return was probably closer to 4.5%.
The challenge is that if someone draws 6.64%, the capital will start eroding after about seven years, while the income will grow for about 13 years before it starts falling off (assuming CPI plus 3%type return), Gradidge says.
In a scenario where someone draws 6.64% while getting a 6.5% return, their capital starts eroding immediately, while their income will start eroding after about 10 years (assuming market returns continue as they are). Also, people are living longer.
Gradidge says investors should scrutinise their fees. If a portfolio only includes active funds and fund-of-funds, costs are likely to be quite high. Typically, an LA investor shouldn’t pay more than around 1.7% in total.
While retirees in LAs should beware the pitfalls of fixed inflation increases each year, asset allocation is also important.
For most investors, a multi-asset moderate equity fund should suffice if they have the risk tolerance for it and aren’t drawing too much. Retirees should also look at the LA’s structure, he adds.