Pensioners who buy a living annuity with their retirement savings do so, amongst other reasons, so that they can have some control over how much they draw to live on. Known as a draw-down, this is limited by minimum and maximum percentages of their total capital each year. A living annuitant must draw a minimum of 2.5% of their residual capital at the policy anniversary date. They may draw up to a maximum of 17.5%.
They are locked into that income for the next 12 months. While this creates a short-term income guarantee, it also makes it impossible to adjust that income in the event of a market crash or change in personal circumstances.
At 17.5%, an annuitant is drawing down a high proportion of their savings. Unless their portfolio has a stand-out year and grows more than it loses to draw-down and fees, the annuitant will face an immediate reduction in income. This is exacerbated by any purchasing power lost to inflation. Reaching this so-called ‘point of ruin’ is the major risk with a living annuity.
Annuitants, who draw down conservatively from the outset and take only inflationary increases thereafter, are able to avoid the ‘point of ruin’ for many years. Yet the longer they live, the more likely they are to get there eventually. This is the so-called “longevity risk”.
As part of government’s pandemic relief measures, it has temporarily eased up on the above restrictions. The minimum draw-down has been lowered to 0,5%, the maximum increased to 20%, and changes can be implemented immediately.
Raising the upper limit to 20% is a short-term fix that creates an even bigger problem a few months down the line. Unless asset values bounce back dramatically over the next few months, these investors will face a considerable reduction in income as soon as their next anniversary comes around, due to the erosion of their capital base. That effect would be magnified if the 17,5% draw-down limit is back in place by then. Their future lifestyle will be severely compromised.
Even if the higher withdrawal is just a once-off, the longevity of those savings will be considerably reduced.
According to the Association of Savings and Investments South Africa (ASISA), the annual living annuity draw-down rate has averaged around 6,7% in recent years. Fees, which in some cases are close to 3% pa (0.75% for advice, 0.25% for administration, 1.5% for investment management and 0,4% for VAT) pushes the effective annual draw-down close to 10%.
That is twice the recommended rate. Numerous studies suggest that annuitants should draw no more than 4% to 6% of opening capital, including fees, growing with inflation thereafter (depending on how savings are invested, and future return assumptions).
If the average annuitant is already using up their savings at twice the recommended rate, raising the upper draw-down limit to 20%, even as a once-off, puts them on the ‘autobahn’ to ruin, and the prospect of a drastic cut in lifestyle much sooner than they expected. Increasing longevity means they will spend even more time in a state of financial purgatory.
One thing that this pandemic has done, worldwide, is expose the many fault lines that run through our societies: the pervasive inequalities that put certain groups more at risk than others, the poor lifestyle choices that have come home to roost, and all the (in)adequacies in terms of healthcare services, social security nets, financial resources, economic models, leadership, and the concept of solidarity.
On a smaller scale, it has once again highlighted the vulnerability of pensioners, who must manage their own retirement income, along with the associated investment and longevity risks.
The government’s relief measure, temporarily increasing the upper draw-down to 20%, does not help their cause. Even if we ignore the obvious and overlooked fact that annuitants’ income was in any event guaranteed until their next policy anniversary date, and that the markets had recovered most of their losses by the time the relief measures were introduced, it sends the wrong message, that drawing down at 20% is appropriate at certain times. It is, but only once longevity risk is taken off the table. Unless the government has some inside information about how the pandemic will affect all our pensioners, we are not there yet.
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Short-term relief for pensioners will equal long-term pain for many
Many of those pensioners who take advantage of the government’s Covid-19 relief measures (to temporarily increase the proportion of savings they draw), which came into effect on 1 June 2020, will find that a little short-term relief will mean more pain in the long-term.
