One sneaky fact about retirement, that many of us often overlook, is that it arrives faster than we expect! Essentially, we are never too young to think about our retirement investments inside of a healthy financial portfolio.
As you read this blog, please also bear in mind that each person’s retirement goals are unique and may have different investment vehicles inside their retirement investment plan. This post refers specifically to living annuities - and can be rather technical. If you have specific questions regarding your portfolio, then let’s set up a meeting to address your personal situation.
South African pensioners have about ZAR350 billion invested in living annuities from which they can draw a pension that is equal to between 2.5 and 17.5 percent of the annual investment value.
Most people appreciate that living annuities come with many risks - from investment markets delivering poor returns, to outliving their capital. Nonetheless, 90 percent of people who belong to retirement funds buy living annuities instead of guaranteed annuities, and are willing to take these risks in the hope of greater returns for themselves and their heirs. However, the Financial Services Board (FSB) is concerned that living annuitants may not fully understand one of the biggest risks of the product – that is the risk of depleting their money prematurely.
In an article published on Personal Finance, Marc Thomas, the manager of client outcomes and product research at Bridge Asset Management, explains the situation simply. “Unit trust funds that have the best returns in terms of the value of the units could still do poorly in terms of providing an income that buys back the units lost when drawing an income.”
As the units are depleted, the capital value of the annuity declines. However, to compound this decline, the yield earned on your investment is also reduced because you have fewer units on which to earn an income.
Sadly, as a result of not fully appreciating the risk involved, many pensioners are forced to dramatically reduce their pensions at some stage of their retirement because they have simply sold too many units. If they see healthy returns, they surrender to a false sense of security and believe they can continue drawing a high income, or even increase it further.
It is often the case that the income earned by the portfolio only covers around a third of the income drawn. Thomas warns that “if you are selling more units than you are buying with the dividends and interest your investments earn, you will eventually run out of money... But if, over time, the units you withdraw equal the units you can buy with the income earned from your investments, you will not run out of money.”
So how can you prevent this from happening to you?
An obvious solution would be to ensure that you have a portfolio that earns an income that matches the amount you require – or at least a very high proportion of it.
Additionally, when reading the statements that you are sent, which include information about the units sold over the period, it is important to focus on the unit balance. Thomas emphasises that “living annuities and annual income withdrawal decisions should not be managed solely on capital values, which can be highly volatile in the short term... Instead, unit balances and the income produced by the investments should be monitored constantly.”
In recent times, providers have also launched products with more guarantees, as well as a living annuity with an underlying investment in a guaranteed annuity that provides an income for life. It is, therefore, important to find out what options are available to you and to assess the risks so that you can properly prepare for your retirement – without surprise cutbacks.
The important thing is to not be fooled into complacency while drawing an income. Even if a fund produces healthy double-digit annual returns over a decade, pensioners have been warned to not draw more than 5% per year.