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What Asisa’s average living annuity drawdown rate reveals

And what investors need to keep in mind.

If the average mark for an internationally standardised grade 12 maths test written by 10 South African students is 52%, is that a good result?

One could argue that it is, particularly if you consider that the quality of the country’s maths and science education is dismal.

But what if the result sheet shows that four people got full marks, while the other six only got 20%? This would mean that more than half the class failed the test.

Yet if everyone in the class got 52%, the average would remain the same.

Admittedly, the example is extreme, but it demonstrates the challenge in using averages to draw meaningful conclusions.

According to the Association for Savings and Investment South Africa’s (Asisa’s) 2017 Living Annuity Survey, the average living annuity drawdown rate remained almost unchanged from a year before at 6.64% (see below).

2011

2012

2013

2014

2015

2016

2017

6.99%

6.77%

6.63%

6.59%

6.44%

6.62%

6.64%

Legislation allows retirees to draw between 2.5% and 17.5% from living annuities per annum, but with these vehicles the pensioner bears the investment risk (that investment returns won’t be enough to compensate for drawdowns) and the longevity risk (that the money will dry up before the pensioner passes away).

So what can be deduced from the Asisa average in isolation?

Not a lot unfortunately.

Craig Gradidge, investment and retirement planning specialist at Gradidge-Mahura Investments, says the average would be skewed by people with bigger living annuities who tend to have lower drawdowns while those with smaller annuities generally have bigger drawdowns. As a result, the average may hide more than it reveals.

It would be helpful to get a median figure or see a breakdown of size buckets or the distribution of drawdown rates, but even that may offer limited insight.

Taryn Hirsch, senior policy advisor at Asisa, says the problem with living annuities is that the industry does not know the personal circumstances of the underlying annuitants. They don’t know whether it is the individual’s only annuity (they may have more than one) or whether they have other assets that can supplement their annuity income. Some individuals may still be earning an income in retirement and may be drawing a high percentage from a small annuity with the intention of depleting it as soon as possible.

“I think it is risky [to read too much into the average] because I think it is open to misinterpretation and I think people can draw the wrong conclusion,” she says.

As such, it is very difficult to get a clear sense of the percentage of living annuity policyholders who face a very real risk of running out of money in retirement. Yet there have been growing concerns that retirees have not adjusted to a lower return environment. In fact, some industry commentators believe a crisis may become visible within the next decade.

Pensioners who choose these products need to take a good look at their unique circumstances. Drawdown rates, asset allocation and annual increases are very important as these are key inputs retirees can manage, whereas inflation, longevity and market returns are out of their control.

Hirsch believes pensioners and their advisors need to be commended for continuing to be economical rather than increasing their drawdown rates (on average).

“We have to accept that many pensioners are finding it increasingly difficult to maintain their standard of living without adjusting their drawdown rates upward.”

Gradidge says it is “great” that the drawdown rates are stabilising.

“I think the big challenge though is that returns – particularly over the last four to five years – have not been there,” he says.

Over the last three years, the average multi-asset medium equity fund delivered 5.8% before advice and administration fees, which means the average return was probably closer to 4.5% (nominal return net of fees). Even over five years, the latter figure is only around an estimated 6.5%.

The big challenge is that if someone is drawing 6.64%, the capital will start eroding after about seven years, while the income will grow for about 13 years before it will start falling off (assuming a CPI plus 3% type return), Gradidge says.

In a scenario where someone is drawing 6.64% while getting a return of 6.5%, their capital starts eroding immediately while their income will start eroding after about 10 years (assuming market returns continue on the current trajectory). At the same time, people are living longer.

So how should investors respond?

Gradidge says investors should scrutinise their fees a lot closer. If a portfolio only includes active funds and fund-of-funds the costs are likely to be quite high. Typically, a living annuity investor should not be paying more than around 1.7% in total (for advice, administration and investment management).

While retirees in living annuities should beware of the pitfalls of fixed inflation increases each year, asset allocation is also important.

For most investors, a multi-asset moderate equity fund should suffice if they have the risk tolerance for it and are not drawing too much. Retirees should also look at the structure of the living annuity, he adds.

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My conclusion from reading this article is that the investment/insurance companies can not provide me with a return, which after deducting their fees is higher than inflation.

Surely with modern technology it should be easy to show the actual % of people in each drawdown percentage group?

Yes , to calculate the average draw down you must surely have the individual figures to start with .

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