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Can your living annuity go the distance?

Significant risk that you could run out of money by drawing 5.7% per annum.
It seems pensioners are finding it increasingly difficult to maintain their standard of living in a low-return environment. Picture: Shutterstock

Over the past two decades, the JSE’s bull run has masked several of the potential problems faced by retirees.

But as returns have faltered, and amid increased longevity, there is growing concern that many retirees in living annuities could run out of money.

It seems that pensioners are finding it increasingly difficult to maintain their standard of living in a low-return and relatively high inflationary environment.

Andrew Davison, head of implemented consulting at Old Mutual Corporate Consultants, says living annuities were only introduced in South Africa in the 1990s. Despite one or two hiccups, returns over the last two decades or so have been very good and there hasn’t really been a lot of time to see how these vehicles would fare under various economic conditions.

Since 2003, living annuities have been an increasingly popular choice among retirees. Living annuities allow pensioners to draw between 2.5% and 17.5% of their capital each year and as a result, people with limited funds can draw a higher initial income than would generally be available by choosing an alternative vehicle. The option to leave the remaining capital to beneficiaries at death also seems to be an attractive proposition. But while the product arguably offers greater flexibility than a guaranteed annuity, the risk that investment returns won’t play ball, or that the pensioner would live longer than expected rests squarely on the individual’s shoulders.

But how would living annuities have performed, given the economic conditions prevalent over a longer time frame (assuming these products were available)?

A study conducted by Davison using actual return and inflation data since 1950, shows that with an initial drawdown rate of 5.7% (adjusted for inflation each year) and annual fees of only 1%, living annuity policyholders would have run out of money before 30 years in retirement more than half of the time (45 out of 75 cases). The earliest failure was after 13 years. Note that this assumes that the drawdown can exceed 17.5%, which it can’t in reality. However, a few years prior to this depletion outcome, the 17.5% limit would have been reached and the pensioner would experience a precipitous decline in income. The end result in terms of lifestyle would thus be very similar to “running out”.

A number of pensioners already ran out of money after 15 or 20 years in retirement (nearly 20% of cases).

Source: Andrew Davison

The drawdown rate in this analysis was chosen as follows. Over the period the median real return of the investment strategy employed by annuitants was 5.5% per year, and a pensioner drawing 5.7% on this median scenario, paying annual fees of 1% of assets, would have run out of money after exactly 30 years. This is somewhat lower than the average currently prevalent in the market. According to the Association for Savings and Investment South Africa, living annuity policyholders withdrew on average 6.62% of their capital as income in 2016 compared to 6.44% in 2015.

The study assumes that the first person retired on January 1 1950 and that another person retired every six months thereafter. All pensioners (75 in total) followed the same investment strategy (see asset allocation details in graph).

Return environment

Davison says with the exception of the global financial crisis and the last few years, returns have generally been very good over the past two decades or so. This has masked the fact that a lot of pensioners have drawn more income than is really sustainable.

The study highlights that at current average drawdown levels, pensioners do run a significant risk of running out of capital in retirement, even assuming relatively favourable return conditions, which is not currently the case.

“We’ve got this dangerous situation where people are drawing too much.”

Apart from a sustainable drawdown rate, investment returns in the first few months or years in retirement also play a significant role in determining the outcome. This is sometimes called “sequence risk”.

Davison says if a pensioner is exposed to a market correction (or just generally poor returns) during the first few years in retirement, it becomes very difficult to recover because the portfolio has to weather the income as well as the investment drawdown. In around 30 of the 45 cases that were depleted after 30 years, the returns relative to inflation in the first five years of retirement were below the long-term real returns from the investment strategy.


There is also a risk that retirees could experience a false sense of security as long as investment returns are in line with drawdown rates, without realising the inflationary impact. This is because it appears as if they are not eroding their capital, yet they are gradually drifting backwards in real terms.

If a pensioner starts out with R1 million, draws 5.7%, and receives a 5.7% (after-fee) return, he would still have R1 million after one year, which could create the impression that “all is well”. But once the inflationary impact is taken into account (assuming the scenario is repeated for a few years) capital is soon eroded.

Davison says in a high-return environment, retirees could initially get away with a drawdown as high as 5.7%, but once fees and inflation are taken into account, especially in a low-return environment, the picture changes dramatically.

Effectively, returns haven’t been able to replace average drawdowns over the past few years – even before inflation and fees were taken into account.

If retirees draw 5.7% in an environment where inflation is around 5.4%, fees are 2% and returns are low, protecting capital becomes very difficult.

“So you are slowly running out of money, but you don’t know it, until you get to a point where your capital really starts to decline in real terms and even in nominal terms and the problem is from there it is a very rapid process [of running out of money].”

Davison says many retirees may not have reached this point yet, but their capital and their income may already be slightly lower in real terms than it was some years ago.


To improve the probability that a pensioner’s money would go the distance, there are some actions that they could take (for example if the returns in their living annuity during the first few years in retirement are weak).  

Since the first few years in retirement are crucial, one possibility is to take no inflationary increase during the first few years in retirement. Assuming they do this for just four years, the money would have been depleted in only 23 out of the 75 cases (compared to 45 without any action). Of course, their standard of living would be impacted, especially if inflation during this period was high.

Another alternative would be to reduce the drawdown rate by 15% say, from 5.7% to 4.8%, which produced a similar result (depletion after 30 years in 25 out of 75 cases).

Unfortunately, even taking such drastic measures didn’t necessarily protect pensioners from running out of money.

But since most South Africans already struggle to maintain their standard of living in retirement, it is questionable whether retirees would be willing to make such sacrifices.

In terms of assessing the sustainability of drawdowns, Davison says that Old Mutual’s SuperFund Umbrella, which recently launched a default living annuity, recommends that retirees draw 4.2% of their capital as income at age 65 if they’re male and 3.6% if they’re female.



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Let me make it clear that these recurring articles quoting the studies (models) of life insurance companies are biased, one sided, skewed and partial. It does not take cognizance of the average investment position or sources of income of retirees. It looks at living annuities in isolation as though that is the sole retirement provision of the average retiree and it compares apples with pears.

If the life insurers and S.A. banks are genuinely that concerned about the risks, longevity and performance of living annuities, why don’t they set the example, do the right thing and act first by cutting on the exorbitant platform fees and investment fund charges applicable to living annuities. Most living annuity platforms and investment funds (unit trusts) are owned by insurance companies and banks.

The study (model) referred to in the above article has many shortfalls, incompatibilities and inaccuracies. It is flawed to say the least. One just cannot use financial models of investment and equity data between 1950 up to 1980 (the 30 year period referred to) and apply it to make current projections and predictions. The world has changed since then.

During the “prehistoric” period (1950 to 1980) South Africans had a very small investment universe limited to a different equity market at the time, to just a few South African unit trusts and insurance funds. Rand denominated offshore investment funds, money market funds, regional funds, theme based funds, dividend and income funds, etc were not yet available to the South African public. Guaranteed insurance annuities similarly did not yet offer an inflation linked income option. Both the inflation rate and equity return were performing drastically different than the period 2000 forward, to mention but a few reasons why this study or model is flawed.

Importantly it also does not disclose the comparing effects of a guaranteed insurance annuity. If “25 out of 75 cases” (being just one third) would have depleted their living annuity in 30 years time in this flawed model, so what? In this example the person would have been 95 years (65 plus 30 years). This is ridiculous as the average life expectancy of both males and females were about half this 30 year term at retirement age (age 65) back in the 1950’s and 1960’s. It’s a flawed model on more than one level.

What happened prior to the introduction of living annuities was that the insurers made huge profits on their guaranteed annuities where the annuitant died prior to the term of his / her life expectancy as any balance of such annuities (single life annuities) is not payable to the spouse or heirs of the deceased but is profit for the insurance company and for double life annuities the income (and therefor also the balance of the annuity capital amount) is halved at the death of the first of the two annuitants (double lives) also resulting in a handsome profit margin for the insurance company.

Lets start talking about how one should manage the value of your living annuity in current market conditions, what options are available, how to comprise your fund selection at various stages, how to react to changing market conditions, what the effect of platform fees and investment fund charges are, why ETF’s and ETN’s are not available for living annuities, what one could do to earn an additional income after retirement, how to manage your discretionary investment capital or rental property, etc and about what is the real differences between a living annuity, a pension fund income and a guaranteed annuity. Lets educate rather than driving fear into the old folk by telling them their pension provision (or part thereof) is likely to run out based on flawed studies (models) which seeks to proof a point that is in any case very debatable.

As a retiree myself.

What a nonesense article. It all depends on the rate of growth of the underlying investments as to how one will end up.
I have a living annuity which I manage myself I have achieved an average return over the the last 7 years of more than percent per annum. Not difficult. I draw down about 8 % per annum, so my capital continues to grow at more than the current inflation rate after the drawdown. Pensioners not getting similar investment returns have poor financial advisers who they should fire. I fired mine and have never looked back. Anyone interested I am happy to assist.

Ianben, I share your sentiment. I am sick of predictions that focus on worst case scenarios. Apart from that, I sometimes get the feeling that the big guns invest on behalf of their clients but when it comes to returns, they take their (fat) cut first in the form of fees before handing the crumbs to the client. Over the years I have steered away from the established, well known and popular names. There are huge cost savings doing your own thing, simply by reading, researching and making solid decisions. A saving of 1 – 1.5% on fees over a long period makes a big difference on returns.
Yes please, please share your success recipe.

Hi ianben, I’m interested in finding out more about why and what you invest in

Hi Inge,

Please could you ask Ianben to write an article for Moneyweb? This might help more people than the article currently commented upon. I know I could do with huge help. I have a Preservation Fund and a RA that I have not drawn upon (at age 70) as I simply don’t know what to do with them, and I am really wary of signing myself up to something like Liberty again – which has not served me well over the years, or to someone who profits more than I do from my hard-earned savings.

ianben- 1% interest earnings per month is very attractive (12%/year). I am currently bound by Regulation 28 instruments due to my previous employers pension fund. I only managed to gain 7-8% over the last 3 years from a coro LA with a unit trust selection.
Please advise a selection/strategy that can earn a better return.

@ianben: I am about to convert my provident fund to a living annuity and was considering Allan Gray. Would love to hear your thoughts, pls drop me a line

Those companies peddling RA/LA are very much like the watch salesman at the robots – they open their jackets to display a number of gleaming time pieces but don’t tell you about the mechanisms inside the watches which are all suspect and will make your timepiece (if bought) useless over time.
My experience with LA.s is that benchmark are used as a means of determining the fund managers competence, yet the bar is set so low the only winner is the management company as the fund manager draws a salary and gets substantial commissions for exceeding the benchmark. There is absolutely no focus on stretch targets – for arguments sake CPI plus a percentage above CPI (CPI 6.1% plus stretch target 4% = total 10.1%) If the fund manager fails to meet this target fees must be waived automatically. Currently the fund managers don’t care whether their funds perform or not as the fees are of a sufficiently high return as to not rock their boats at all. They also don’t share in their poor performance by having their salaries/commissions readjusted downwards – so no challenge to their performance

Steer clear of investment funds that charge performance fees, its another pitfall that offers nothing in return, exactly because of:
a) unacceptable poor benchmark and low performance hurdle rate;
b) no punitive measures if the investment manager do not outperform the ridiculous low benchmark;
c) reasonable performance is more often as a result of market performance than as a result of any alpha generated by an awake and sharp investment manager;
d) no waiving of a portion of the fund fees when performing dismally;
e) total over charge with fees whilst actually behaving worst than most low cost passive funds;

Not to be touched! I would move my funds out of performance based funds had fallen pray to this trap. There is enough other choices without the absurd performance fee layer.
The unit trust industry needs a serious shake-up, awakening and disruption.
The industry and ASISA has become very much complacent and burrowing the misbehavior and misappropriation that takes place. The FSB recklessly discarded the oversight duties and deregulated the industry some time ago.
What else could be expected when the industry has free range to do as they please.

A very good article. Readers don’t see that this article is stating the power of Mathematics in investing. I love the effort that went into all the different scenarios and the results we got. My dad also realised that he was depleting his capital and adjusted his drawdown to the minimum allowed % for 2 years. It allowed the investment to recover and the drawdown is back at the normal rate now. As the article states – it is amazing how quickly the capital disappears when the drawdown starts exceeding the growth – a powerful Mathematical principle.

‘My sole retirement is an LA crowd’ are rightly panicking.

The low returns in the future could be real.


Anti capitalist everywhere

Socialism gone mad grabbing ever more taxes

Excess competition forced down on companies by a tax gathering Competitions authority. Yes
excess competition will force companies out of business. This happens offshore too.

Why take a risk that you will never recover from?

Those peddling 8% + good luck to you. As are those that mix apples/ pears: what happens if one does NOT have other funds to draw on? In any event that is just a strawman.

It is a good article.

JapieM, that is a basic principle with money and common knowledge. The so called “study” done by Old Mutual is still very much flawed and the figures presented is non-reliable and inapplicable.

Pacaratac, “if one does not have other funds to draw on” and thus no other pension provision, that person did not take his retirement provision seriously and was all along in the trouble. If you don’t provide properly, you can of course expect to run into trouble. That is not the argument I make in my reply. I question the relevance of the data used to extrapolate the points made in the so-called study and I give various and valid reasons why it is flawed. I’m not grabbing at straw, neither am I a man of straw. Quite the opposite you little arrogant hide-away.

End of comments.



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