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How do the numbers work with living annuities?

Many people who have too little capital saved at retirement opt for high percentage pension draws.
Image: Shutterstock

I would like to draw attention to the risks to living annuity holders caused by over-optimism about future investment returns.  As a Cassandra I have produced a number of articles on the dangers of investing in a living annuity without understanding the risks.  Sadly, it seems, I am being proved right in a way I would never have wanted.

For those who haven’t yet invested in any of these products, living annuities provide a different approach to investing in a pension.  The rules are pretty much the same as for any lump sum investment from which investors want long term income.  Simply put you invest the lump sum to grow, both with capital growth and retained income.

The idea then is that you withdraw an income that will increase to keep pace with inflation.  But you will find that while the theory is simple the practice is a little more tricky.  In fact it can be more than a little tricky.

I think this is best illustrated with an example.  I invest R1 000 000 in such a pension and I draw a pension of 5 percent per year.  I will need at least enough investment growth in that year to replace what I drew as income.

But if I only replace what I took out I will sit, at the end of the year with the same amount of capital as I started with.  Well, that’s not quite true because costs must also be paid.  So if I draw 5 percent of capital for a pension and my costs are 2 percent of capital, I will need to earn at least 7 percent growth.

So 7 percent is the actual size of my pension drawdown.  If I can only replace that with those earnings each year, I must increase the percentage that I take out if I am to have an annual increase in my pension.  But every time I increase the draw, I must increase what I earn on my investment.  Only one or two years of poor performance and I will be in trouble.

A better way of dealing with this is to review the draw in terms of the full equation.  The full equation tells me that if I draw a pension of 5 percent of the capital each year, have costs of 2 percent of my capital each year and have an inflation rate of 6 percent per year I really need investment earnings of 13 percent each year to keep my pension rising by inflation.

In current markets 13 percent may well be a bridge too far and so if I am to have a shot at my pension keeping pace with inflation, I need to have a really hard look at this aspect.  “Aha”, you may say, “but as you get older you spend less and of course it’s not forever as you have to die sometime.”

Well, I don’t know about you but I am not prepared to plan on running my investment capital down to zero by a particular date, when I will have no safety net if I live longer.  It makes sense to me, to manage my living annuity as though I will live for ever.  Also of course we have no real idea of our personal inflation rates so that assumption may have to change.  [medical inflation 2 %%]

That leaves me with a hard alternative.  I must somehow find a rate at which to draw my pension (as a percentage of my capital) to fit in between inflation and costs without exceeding the total investment returns that I earn.  I must be careful about over optimism about expectation of future investment earnings.  Predictions of future earnings are guesswork something that that the Covid 19 outbreak has helped to demonstrate.

Many people who have too little capital saved at retirement opt for high percentage pension draws.  Unfortunately that either reduces their capital more quickly or it requires them to earn investment returns that are just impossible.  Living annuities are excellent products but like firearms you really do need to understand the risks.

Dave Crawford CFP® Retirement Fund Member Educator Planning Retirement.


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Most healthy people retire far too early. People are living far longer. There is no excuse to stop working or running a business once you hit sixty and are still healthy.

While we are working and saving for our retirement, we are also working and saving to fund the retirement of complete strangers.

We are taxed on our income and taxed on capital appreciation. Those taxes fund the salaries and pension fund contributions of government employees. Our labour also provides funding for the social grant. All those unknown individuals use the power of their vote to extort contributions from us, while we are trying to provide for ourselves.

How can we expect to find sanctuary in the law, when the law is diverted to plunder our property? How can we manage to save enough for retirement when the unemployed masses use their power over the legislature to divert our savings for their own benefit?

Inflation, and especially the interest rate on the goverment bond that is below the rate of inflation steals the purchasing power of our pension fund to redistribute it among government employees and reciepients of the social grant.

It is easy to provide for retirement if we are able to save the fruits of our labour. It is impossible to provide for retirement if the law allows everybody else to syphon off the fruits of our labour through various taxes, inflation and currency devaluation.

The system punishes frugality and rewards extravagance. This is socialism, where everybody lives at the expense of everybody else.

Sounds as if you’d be better not using the facilities on offer, you should just put your monies under your mattress and manage it yourself.

Exactly what I’m doing, offshore of course. Also not interested in interest-bearing investments that pay a negative yield after taxes and inflation. But go ahead, don’t mind me, see if you can beat the system. Good luck.

I read recently that costs (i.e. fees) accumulated by the time of retirement for the average retiree have typically reduced his retirement pension pot by at least 30%. That’s bad enough. What’s worse is the ongoing 2% or so creamed off the subsequent living annuity in fees – a figure not a lot less than the 2,5% minimum draw down permitted and a fair proportion of the recommended 5-6% the retiree has to live off. So for every R100 the pensioner earns from his investment, the investment managers a.k.a. “advisors” take as much as R40. There you have the problem.

It’s not a problem – it’s an opportunity for you!

Here’s your chance to start a living annuity provider charging next to nothing for the administration and investment of living annuities. There’s tens of thousands of potential clients out there who will love your low-cost solution. In no time at all you’ll have created a massive company with a huge client base!

So you’re only real work is to consider how to pay the capital providers to start off and finance your business, how to create and continue running a successful marketing campaign (and the small issue of paying for that), how to afford and maintain an IT system dealing with all the complexities of living annuity fund administration, online payments, tax directives, cashflows to and from assets managers, real-time online balances, etc (word of warning: these IT capabilities are extremely expensive, but I’m looking forward to your solution to creating and maintaining this for next to nothing), how to attract and remunerate the best administration staff (when you pay staff less than your competitors, the best staff will leave, and you’re stuck with those staff who can’t find other better-paying employment, and that’s when the administration errors start and your reputation goes out the door), and how to deal with the magnitudes of ever-changing legislative and compliance requirements.

Good luck – may the odds be ever in your favour!

No Need to start one up. Just go look at the 10X website.

Good article, retired in 2008, invested half of my payout in living annuity and balance in fixed term, today my living annuity still worth more than amount invested in 2008,due to selecting the right investments dispute drawing about 6 percent, just be aware what’s going on and don’t be scared to change investments

A very relevant article: interestingly my living annuity “manager” has recently advised me to change to a guaranteed annuity and abandon trying to leave my family some sort of pot : they forsee minimal returns in the future and are embarrassed at what my funds are doing .!!!

If only there was an investment company that was willing to take 10% of the annual growth of my capital rather than a fixed 1 to 2%. Then I would have a lot more trust in them.

I think 4% is the maximum you should withdraw from a well diversified portfolio each year. This is a sustainable amount of income to take each year to ensure you will not run out of money. I’m currently drawing 5% from my LA, but when I include my entire portfolio it is around 3% per year. I have chosen to keep nearly 70% of my investments offshore which have provided very good returns since my retirement six years ago. I don’t plan on leaving South Africa, but offshore investments offer better diversification and far greater opportunities. We hope to continue living comfortably within our means for the rest of our lives and someday in the distant future leave some for our daughters to inherit.

I would start by taking my funds away from the 2 to 2.5% managers. Over time all end up giving you the index. Go with someone like 10X where you get what they promise. I am paying .46% on my preservation fund with them. Much better than the fee I paid to XXXXX who actually underperformed the market and then brazenly took 2.5% from my funds.

I wrote this reply on April 15, in reply to a Moneyweb article titled ”More cuts coming but pensioners won’t be happy”

Brenthurst Whealth carried a plethora of aticles – advising pensioners to get out of their ”non performing Annuities”.

And my view in thebeginning of the years that the USD/ZAR will end the year between 14 and 15, is also now starting to take shape…
and to all those pensioners that got spoofed by the ”invest ooshore” histeria, must now bear the brunt of a almost 4 % appreciation of the ZAR against the USD – Thanmks Magnes and others!

”The further backward you look, the further forward you can see’’

Winston Churchill

No – pensioners haven’t been making a killing – some of them lost more than 30 % of their hard-earned funds!

Pensioners beware – take note where your pension funds in your Living Annuity is invested!
I have noticed a lot of millennium ‘’screen watching junkies’’ here, with almost no experience (besides what you can pick up from Google on investment products etc.), and/or a couple of years at Wits, UCT, etc.
I clearly remember the ‘’ Third Circle MET Target Return Fund’’ (a local Unit Trust) cowboys a couple of years ago – who lost 66 % in two days!
Methinks it was very easy for them to fool their away around it at first, as the margin account at the JSE/Safex was reported as cash while the ‘’investment’’ was kept in a high leverage Option contract – the so-called zero-cost exotic option structures.
The Condor Options strategy (when the market became volatile), crashed into a butterfly spread option and all hell broke loose. The investors were left with a margin call. The moral of this story was that these so-called highly educated millennials were highly qualified derivative dealers (without any experience) – but the money was lost, before the Index bounced back 90 % in the next 9 trading days thereafter. Pensioners were told that these so-called Unit Trusts were long-term investments – and some pensioners did lose a lot of money on this rubbish!
Pensioners with LA should scrutinize their fund managers ‘’Fund Fact Sheets’’ very carefully – or suffer the consequences on their hard-earned savings.
I have expressed my opinion on this Web a couple of times (and as per usual was insulted etc), but after another severe market crash after calling for the Regulators to investigate the market shenanigans due to the risk-reward ratios of these products for shorter termers like pensioners. These types of derivatives won’t really add value, nor do they protect anyone who happens to be at the wrong end of the option. Why should retirement funding portfolios be invested in derivatives at all? The problem also seems to be that you can leave your funds in the hands of an incompetent bunch of speculators without any accountability.
I think the improper and imprudent use of derivatives and unprofessional way that it is sold to the pensioners, is a confirmation that the fund managers themselves don’t understand these products they are investing their client’s funds into

Excellent article by Dave Crawford. One of my best investments was to sit with him a couple of times when approaching retirement. LAs are a very small part of our retirement income.

“Living annuities are excellent products but like firearms you really do need to understand the risks”. So then, what did you do with your pension as you have stated that “LAs are a very small part of our retirement income”? I am asking because I’m getting to the stage where I need to purchase a pension with my RA. All inputs will be appreciated.

End of comments.





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