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Retirement is not what it used to be

The increased use of living annuities has brought huge challenges.

There has been a big change in the South African retirement industry over the last 10 to 15 years. This has been the huge growth in the use of investment-linked living annuities.

These are products that give investors control of their money after retirement. Instead of buying a guaranteed pension, they invest it in portfolios of their choice from which they then draw an income.

“In March 2000 the total assets in living annuities was R15 billion,” explained Bridge Fund Manager’s Marc Thomas at the launch of the South African Independent Financial Advisor’s Association (SAIFAA) on Tuesday. “In 2012 that had grown to R139 billion. At the end of March this year, we reached R374 billion.”

In the first quarter of this year alone, R18 billion went into living annuity products. This was 56% of all inflows into the collective investment scheme industry.

This represents a fundamental change in what South Africans are doing with their money in retirement.

“Asisa statistics show that around 90% of retirees are choosing living annuities,” said the head of projects at Sanlam Employee Benefits, David Gluckman. “Guaranteed annuities have not really been popular for many years.”

Complexities

There are many reasons for this. They include the lower incomes offered by guaranteed annuities in recent years due to low interest rates, the fact that any money remaining in a living annuity reverts to the investor’s estate when they die, and that many people feel more comfortable being able to adjust their income.

Cynically, living annuities have also been preferred by financial advisors because they earn ongoing commissions from them. They therefore see less benefit if they direct their clients to a guaranteed annuity.

The greater use of living annuities has however brought a great deal more complexity to the retirement industry. Instead of having a steady pension they can rely on, living annuitants have to make complex investment decisions.

“We all know how to plan for the accumulation phase of our lives,” Thomas pointed out. “We save as much as we can and invest with as much growth as we can, and we will get there or thereabouts. It’s one dimensional in its thinking. A living annuity is very different, and it comes with different risks. It is very challenging to put a strategy together that takes into account how much I should draw, what my asset allocation should be, what increases I take, when I can take them, and how long will my money will last.”

Compounding this problem is evidence that very few people actually understand the products that they have chosen. Recent Sanlam Benchmark Surveys that have conducted research into the industry found that less than 10% of retirees believe that they are in living annuity products.

“That can’t be accurate, given the statistics from Asisa,” said Gluckman. “It suggests that people don’t know what kind of a product they have.”

Finding a balance

This is very problematic because the greatest risk that investors in living annuities face is the possibility that their money will run out. If they don’t even know that they face this threat, they are unlikely to be managing their investments properly.

“A living annuity needs to pay an income, and it needs to grow that income above inflation,” Thomas said. “To do that, you either have to keep growing the capital faster than you are paying it out, or you have to start giving capital back. That is a very difficult thing to manage over 30 years.”

On the other hand, investors who do recognise this problem may be so fearful of losing capital that they invest too conservatively. This means that they end up drawing income faster than they are growing their assets, ultimately leading to the same outcome.

Christo Lineveldt, investment specialist at Coronation said that this is why South Africans need to appreciate the importance of growth assets such as equity and listed property, even after retirement.

“For clients to sustain income levels for as long as they need to, they need to make sure they have enough growth asset exposure,” he said. “You cannot afford to not take enough risk.”

At the same time, however, investors have to consider volatility due to sequence of return risk. This refers to the problem that returns never come in a straight line, and very poor returns at the start of your retirement can have a major long-term impact as it is extremely difficult to recover them.

“The more you lose, the more growth you need to make yourself whole again,” Lineveldt explained. “If you lose 30% you need to gain 46% to get back. If you lose 50%, you need 100%. And because people are continually drawing from their investment they can’t have big events leading to big losses. It is therefore a balancing act between having enough growth asset exposure and having too much where the downside volatility is too great.”

This just illustrates the complexity that investors face with these products, and why having the proper advice can be so crucial. What’s also critical is that living annuitants have to be aware of what they are paying.

“Consider that if you invest in a fund charging fees of 1.5% and draw 5% from your living annuity, that is the same as investing in a fund charging 0.5% and drawing 6%,” pointed out Meyer Coetzee, the head of retail at Prescient. “And that can make a material difference.”

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Just one point Patrick.
Retirement Capital – pre or post retirement does NOT form part of your estate.
It is therefore important that a Fund Member or Pensioner nominate a beneficiary.

Excellent article. I would like to add just one issue. David Gluckman’s comment is interesting because I see literally hundreds of quotes where pensioners are not even shown guaranteed annuities as an option. The practical fact is that most don’t even know that there are any other kinds of annuity than living annuities. Many advisers don’t acknowledge the existence of guaranteed annuities. Whether that is cynical or not I leave up to you to draw your own conclusions. When the living annuity was launched by Andre Immelman in 1989 a Deloitte partner, who is now retired said to me: ” Living annuities are for the well endowed and the well-informed.”

Marc Thomas makes a really good point with the mention of providing for inflation. Maybe best illustrated with numbers:

Even if you draw 4 percent as a pension
And costs are 2.5 percent (roughly EAC)
And inflation is 6 percent
Total average earning needed will be 12.5 percent

So as the Prescient man says costs and draws interact.

If, as we are told by ASISA, the average draw is 6.48 percent or thereabouts and let’s be generous and say that costs are 2 percent with inflation added that means earnings are required at around 15 percent pa. Yes it is a disaster in the making.

The above illustration is only correct if the pensioner’s goal is to preserve his initial capital in real terms and not comparable to a life annuity that has no end value.

Can an industry participant please explain to me (and the reader public):
a)why ETF options is not available in platform pension products such as R.A’s and Preservation Funds and apparently also not for Living Annuities. Surely it can form part of your equity exposure locally and offshore within Regulation 28 guidelines; and
b) why platform fees for living annuities are so excessively high?
even a 1,5% product fee (not fund fee) equates to a charge of 17,64% p.a. if the average investment is around 8,5% p.a.
Shouldn’t ASISA address the excessive and multi layer fee structures of product providers?
Responses will be appreciated.

Most platforms to have ETF’s avaiable although these ETS’s are unitised for daily pricing purposes.

France:
– ETFs and unit trust passive funds / trackers are available in most retirement funds, so not sure where that comments comes from? Direct shareholding is also offered off many platforms, so the investments you hold don’t even have to be unitised to buy them…
– You don’t have to get a living annuity from a platform. Many of the unit trust Mancos offer living annuities too. You just have a fund range limited to that Manco (which can still be broad and can include passive options)
– ASISA did attempt to address the fees by making product providers declare the effective annual cost or EAC which should include all costs. Not without its issues, but its a start.

Thanks for the info – understood.
Platform fees are however excluded from Total Investment Charges and an excessively high add-on charge – correct?
I make use of Sygnia Manco for one living annuity and which includes a few other Manco options but at double the platform fee and at higher investment fund fees. Their recently acquired ETF DB-X trackers though are not offered as an investment fund option for the Sygnia living annuities. Why not?
My other pension products are with Glacier and Stanlib which both offers a wide spread of investment funds from various Manco’s but again no direct ETF or ETN options – or do I miss something here?

Total Investment Charge (TIC) is different to EAC.

EAC includes TIC (generally the cost of the fund)
+ adviser fees (if any)
+ platform fees (generally none if Manco direct, some if a LISP (e.g. Sygnia, Glacier, etc))
+ other costs (if any – this is a catch-all to mop up anything that doesn’t fit above)

Phone the product provider to ask them why they don’t offer their full range in their living annuity product…

Living Annuities are popular because most people have such poor retiremement savings that they opt for living annuities whith a high drawdown rate to retire “comfortably”. Guaranteed annuities (especially inflation linked) just don’t appear (operative word: “appear”) to offer much bang for the buck.

Definitely a recipe for dsaster in our low investment-growth environment….

18 years ago just before he retired my husband prepared an excel spread sheet – a model for income and inflation. We have used this ever since to help us keep tabs on the LA. We monitor the markets and try to make realistic predictions for inflation and returns and adjust accordingly. The returns in the beginning were excellent giving a good boost to the capital, retiring today may be somewhat different. We also stopped using a financial adviser several years ago thereby saving s several thousand rands a year, we are able to easily change funds within our living annuity ourselves on line. There are no switch costs involved if the switches are made within the companies own funds.
We anticipate living to be 100, 20 something years and could change all or part into a conventional annuity if we became less competent to deal with it .
Financial education should be compulsory in schools, in my experience most so called financial advisers don’t have a clue and are more interested in selling the products than giving realistic financial advice.

I think if you haven’t spoken to an IFA in years you are working with an outdated view of them. The industry has professionalised a lot – it needed to – and will continue to.

But investing and doing the right thing is not difficult if you have discipline. I think the one really useful benefit of a decent FA is holding their clients accountable. Many people, in the absence of someone holding them accountable, will not do the right thing…

I have previously said that annuities are an outdated strategy – they were part of the uk way of doing things (which apparently you still follow). Treasury & ins companies love them as 1) your moneys are locked in to a product in sa & 2) everyone taking a bite of the cherry – your money. The uk threw this model out some yrs ago which led to a big fall in share prices of all annuity providers. It is in fact the ultimate in a nanny state – they think you cannot look after your money! In Aus they were thrown out in 1994 – when the worlds best retirement system was introduced. What is sad is that the system has not really changed since I was doing tax in the 70’s.the world has moved on – a lot since then. I have met ex japies in Aus who cannot close their ra’s &
access all their moneys – even tho’ they left sa years ago. My only comment – get all your money out

Robert, if the ex South Africans that you encounter in Australia cannot get their retirement annuity savings out of SA, then they are doing something wrong. They need to formally emigrate from SA, get a tax clearance certificate from SARS, and give this to the RA company concerned. Done this a few times for clients who have emigrated, and they all got their RAs closed and the funds out of SA.

The sad, but true reality is that the majority of people cannot look after themselves (whether in S.A. or Australia or elsewhere) and need a nanny state to look after them.
This is where Insurance Coys take advantage.

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