In an environment where most South Africans don’t save enough for retirement and where returns have recently been muted, there have increasingly been warnings that retirees in living annuities should consider lowering their drawdowns to improve the probability that their money will last.
But Marc Thomas, manager for client outcomes and product research at Bridge Fund Managers, says it is not necessarily that investors haven’t saved enough – they may have been exposed to inappropriate strategies.
For example, a specific investor may have been advised to save R2 800 a month towards retirement in a fund targeting a return of CPI plus 3%, but in order to provide an adequate income in retirement, this investor should have been invested in a CPI plus 5% portfolio (or should have been saving substantially more in the more conservative portfolio).
Placing an investor in a life stage model (where the exposure to growth assets reduces significantly as retirement approaches) almost guarantees that investors aren’t going to save enough, he argues, as at the time when investors have the most capital and the potential to earn decent after-inflation returns, investors won’t have sufficient exposure to growth assets.
To ensure investors have the best chance of making their retirement capital last, Thomas says all stakeholders in the retirement chain should play a role.
But what alternatives could pensioners consider to improve the probability that their money will last?
1. Reassess your return profile
Investors often try to protect their retirement capital against fluctuation, instead of including growth assets (like shares) in their portfolio, says Pankie Kellerman, group CEO at Gryphon Asset Management.
Instead of keeping a significant chunk of their capital in growth assets for as long as possible and living off the income from the assets, retirees tend to be too conservative and move all their capital into cash or cash-related instruments, thereby locking in an 8% (or similarly low) return. In reality, many investors still need a significant exposure (often 55% to 60%) to growth assets in order to protect themselves against inflation.
Kellerman says by the time retirees realise that they have not kept pace with inflation (after fees), it may be too late to remedy the situation.
In this regard, the first five years in retirement is crucial – investors need a significant exposure to growth assets during this time and need to live off the minimum possible, he says.
Protecting capital against inflation should be a far bigger consideration five years into retirement than it currently is, he adds.
Adding to this argument and talking his book, Thomas argues that tilting the portfolio to get a lot more return from income than capital – generally by having a relatively higher exposure to equities and listed property – could also improve retirement outcomes.
The idea with income efficient portfolios is to limit the capital drawdown from the portfolio to a minimum and to produce adequate dividends, income and interest to meet the pensioner’s income requirements while growing the underlying capital over time, but the investor would also have to be comfortable with relatively higher short-term capital fluctuations.
2. Lower your fees
Kellerman says people with limited retirement savings in particular, cannot afford excessive fees.
On a retirement capital amount of R1 million, every additional 1% in fees is a significant amount of money, and may not necessarily be accompanied by excess returns, he adds.
Thomas says when all the costs related to living annuities are taken into account, many clients are paying between 2% and 3% in fees.
“In a low return environment that is unsustainable.”
In the fund portion of a living annuity, the two significant contributors to fees are global funds and performance fees. Like tax-free savings accounts, living annuities should not be allowed to charge performance fees (which they currently can), Thomas argues.
3. Don’t take inflationary increases during the first few years in retirement
Many retirees find it difficult to reduce their drawdown rate at the outset, but not taking increases during the first few years in retirement lessens the stress in the portfolio and effectively lowers the withdrawal rate over time, Thomas says.
4. Postpone retirement from the pension fund
Although employers would generally still require people to retire from work at a particular age, retirement laws have changed.
Dave Crawford, founder of retirement educator Planning Retirement, says people retiring from employers may now leave their money in their retirement funds and retire from the fund at a later date.
“Any delay in investing in a pension will enable their retirement capital to grow. If their choice is to invest in a living annuity more capital will be available to provide better income,” he says.
If the pensioner intends to invest in a guaranteed annuity – for example a with-profits annuity – the pension should be better due to more capital and a shorter life expectancy, he adds.
5. Use your skills and expertise to generate an income
Crawford says few people consider the value of their work experience, education, training and skills.
“If human capital can produce income in early retirement the need to draw a pension can be postponed.”
6. Explore various annuity options (not just vanilla living annuities)
Investing in a living annuity means that individuals shoulder the risks of inflation, investment and living too long. All are underrated or ignored with tragic consequences, Crawford says.
“There is great deal of ignorance about guaranteed pensions. But of all their qualities, the guarantee that pensions are paid for as long as the pensioner and/or spouse live seems often ignored.”
There are also options to combine a lifetime income (with a guaranteed component) with a living annuity thereby providing a balance between leaving money behind when pensioners die early and feeling secure when they live long.
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