Business

Inge Lamprecht
4 minute read
22 Nov 2017
2:16 pm

‘Crisis of unsustainable retirement income visible within next decade’

Inge Lamprecht

Analysis shows what living annuity policyholders are likely facing.

The issue of unsustainable retirement income – where pensioners see their real income levels erode and eventually run out of money – is expected to reach crisis levels over the next decade.

While the first living annuity policy was already sold in the late Eighties, these products really only became popular in the mid-Nineties. Investors in living annuities can usually draw a higher initial monthly income at retirement than investors in guaranteed annuities due to the flexibility the product provides, but they carry the longevity as well as the investment risk.

Deane Moore, CEO of Just, says even though living annuities have been around for a reasonable amount of time, people who bought living annuities in the mid-Nineties will only start living beyond the average life expectancy over the next decade.

At age 65, the average life expectancy for men is around 18 years. For women, it is 22 years. At the age of 85 the average life expectancy is another eight years.

An analysis Just conducted on data provided by the Association for Savings and Investment South Africa (Asisa) and published by National Treasury in 2012, highlights the problem many living annuity policyholders are facing.

The table below shows the profile of 278 000 living annuity policyholders by age and drawdown category at the time. Living annuity policyholders can draw a minimum of 2.5% of their capital each year up to a maximum of 17.5%. Although one should expect there to be some noise in the data, the numbers provide a good representation of the general profile of policies. According to Asisa the majority of pensioners risk eroding their capital by drawing more than 5% as income.

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Just used the statistics as a base to get a sense of the situation these policyholders would face today by adding actual average multi-asset class investment returns for each year from 2012 to 2016 (ranging from 11.8% per annum for a low equity portfolio to 14.3% for a high equity portfolio over the five-year period). Fees of 1.75% were taken into account and the analysis assumed that retirees would increase the rand amount of their income by inflation every year.

Five years later (end August 2017) the table looked somewhat different.

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Retirees in the lower buckets (those drawing between 2.5% to 5% and 5% to 7.5%) generally did not have to draw a higher percentage to sustain their income in real terms, but people drawing between 7.5% and 10% (roughly 18% of policyholders) had to increase their drawdown to between 10% and 12.5%.

For the latter group of people, investment returns were not enough to sustain their drawdowns and they had to start drawing more capital, Moore explains. Anybody who drew more than 10% five years ago, migrated to the maximum drawdown category of 17.5%.

“I think what that highlights to us is it is a very slippery slope. Once you start drawing your capital – once you get above that 10% drawdown rate – it has only taken them five years to move from that to the maximum drawdown and now their income will start falling in real terms.”

The problem is that a sizeable portion of people drawing 17.5% are still relatively young, and may still need to sustain themselves for a long time.

Moore says in an environment of lower expected investment returns and people simultaneously starting to live beyond their life expectancy, an increasing number of people will face this issue.

And for women, who live longer than men on average and who may also be married to older men, this is a significant problem as they may be faced with a meaningful deterioration in real income levels while they still have years to live once their husbands pass on.

With only a small portion of South Africans in a position to sustain their standard of living in retirement and an estimated 90% of retirees choosing living annuities, critics have argued that people should rather choose a guaranteed annuity at retirement, which guarantees a certain level of income regardless of how long pensioners live.

But Moore says the solution doesn’t need to involve one product or the other.

He says instead of thinking of retirement as one pot of money that needs to last for life, living annuity investors can think of it as two pots – one to provide a minimum level of income to sustain an adjusted lifestyle in retirement and that covers basic needs such as accommodation, food and medical services for life. Any assets available over and above this can be invested for long-term growth.

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