In South Africa we grapple with the problem that people haven't saved enough for retirement. In addition, people are living longer and market returns are unpredictable, so retirees need to be resilient in the face of uncertainty. With most retirees using living annuities to give them an income, many are worried their capital could run out too early. Is there a solution? In addition to saving more, consider using a retirement vehicle that manages both longevity risk and market performance risks.
Living annuities allow retirees to draw down between 2.5 percent and 17.5 percent of their capital a year as income. Unfortunately, many retirees are drawing down too much in their early retirement years, thereby risking having little or nothing left of their capital when they’re older.
There is a way to consume more in your active retirement years, knowing that later on you can fall back on a lower income that at least covers your essential expenses for life.
When it comes to drawdown rates, the industry rule of thumb to maintain a steady level of income throughout retirement, taking increased longevity and inflation into account, is 4 percent a year. However, according to the Association for Savings and Investment SA, the average draw down rate of retirees in living annuities is about 6.6 percent. This implies that more than half of living annuitants are drawing more than 6.6 percent a year, thereby jeopardising their future pension.
Research conducted by Just last year showed that 89 percent of respondents want a guaranteed income for life - something that living annuities can’t provide on their own.
Just entered South Africa in 2015 to address the shortcomings in the annuity market. Its Lifetime Income portfolio provides members with an option to secure a level of income that will never decrease, regardless of how long they live or what happens to investment markets.
Over a 30-year retirement planning horizon, Just Lifetime Income provides a return of 2.5 percent a year above the investment performance of the underlying investment - a balanced fund - to which it is linked. This allows pensioners to draw a higher income in retirement with greater confidence that the income level will be sustainable for life. It is a practical solution to the important gaps left by traditional providers of life and living annuities.
The investment is available on a standalone basis or as part of a living annuity to allow for further flexibility. Currently, three well-known investment managers incorporate the Just Lifetime Income as an underlying investment option in their living annuities.
Recognising the problem of sustainability in a living annuity, the Financial Sector Conduct Authority (FSCA) recently announced that retirement fund members will be able to secure longevity protection within a living annuity. This comes following an exemption from its criteria for living annuities in a default annuity strategy.
In making the announcement, the FSCA said this provides members with greater choice and should encourage them to protect themselves better from poverty in old age.
Deane Moore is the chief executive of retirement income specialist Just South Africa.
PERSONAL FINANCE