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.”
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.”