In South Africa, anyone with a living annuity must withdraw a regular income of between 2.5% and 17.5% of their capital per year. This rate can only be adjusted once every 12 months.
For example, someone with R2 million invested in their living annuity could opt to withdraw 6% per year. That would be R120 000, or R10 000 per month.
However, as we have seen over the past two months, markets can make big moves very quickly. Someone who had R2 million invested at the start of 2020 may find they now only have R1.7 million, if they lost 15% in the market crash.
This could have an effect on this investor in two ways. If they set their income as a fixed amount, that would mean that they are still getting R10 000 per month. Their income would therefore have been protected, but they would now be taking out 7.1% of their capital, which would risk depleting it more quickly than they planned for.
If, on the other hand, they opted to allow their income to fluctuate, 6% of their capital is now only R8 500 per month. They would therefore be facing a significant drop in income.
The complications this could create have not gone unnoticed by the industry. The Association for Savings and Investment South Africa (Asisa) is in discussions with National Treasury about allowing changes to withdrawal rates to mitigate these issues.
“Asisa and National Treasury are aware that the extreme market volatility caused by the Covid-19 pandemic may have left living annuity policyholders with high equity exposure in their underlying portfolios in a position where the drawdown level would need to be adjusted downwards to prevent eating into their capital base,” says senior policy advisor at Asisa, Rosemary Lightbody.
“There is also a concern for annuitants who may have experienced a sudden drop in income as a result of Covid-19 related market movements.”
This will impact retirees in different ways, since anniversary dates vary from one annuitant to the next. Someone who set their withdrawal rate in January is in a very different situation to someone who has to set a rate this week.
Using the above example, an investor might decide that they need to have an income of R10 000 per month, and therefore set their rate at 7.1%. However, if markets deliver a strong recovery and their capital increases back to R2 million, their income would grow to R11 800 per month.
If they don’t need all of that income, shouldn’t they be allowed to reduce it? It would be far better for the sustainability of their investment if they had the ability to make that decision.
Looking for options
“Effectively, we want to ask for flexibility because the capital values sitting in living annuities can change so much,” says Vickie Lange, head of research, best practice and academy at Alexander Forbes.
As she points out, there are two broad categories of people who might need to adjust their rates.
“Certain annuitants would prefer a lower draw rate right now because they don’t want to draw too much out of their living annuities and risk running out of capital,” she says. “Then you have others that might be in a situation where other things have happened and they can’t live off the current draw rate. For example, if someone has a living annuity and their spouse was still working, but their spouse got retrenched. So now you have two people that rely on the income from the living annuity.”
The obvious question is how allowing adjustments could be done, both from a practical point of view and to maintain some level of sensible regulation.
“Changing your income more frequently in most instances is a bad thing,” says Warren Ingram, executive director at Galileo Capital. “In this instance it’s a good thing. But does that mean that you change the law now to make it possible in any situation, or how do you regulate it? My concern is that at least when it can only be done once a year, people don’t start to make bad decisions in normal market conditions.”
The correct approach
A potential solution Ingram suggests is that annuitants should be able to reduce their withdrawal rate at any time. There is, after all, never any harm in lowering the income they are getting.
They should however only be able to increase their rate once a year, or under specific conditions. What those conditions would be, however, will always be contentious.
“Where would you draw the line?” asks Lange. “Who is the one to make that judgement call?”
There is also the question of executing these changes.
“Practically it is not an easy thing to do,” says Craig Gradidge, executive director at Gradidge Mahura Investments. “The product providers would incur significant spend to modify their systems to allow this. They would also need to staff up or restructure their administration teams to handle the additional workload.”
This would place pressure on the providers. However, as Lange points out, Asisa would not have approached National Treasury if this couldn’t be done.
“The industry wouldn’t be requesting something like this if it wasn’t practical from an operational systems perspective,” she says.
There is also the legal question of getting the necessary amendments to make this possible.
“Asisa understands that National Treasury, in consultation with the Financial Sector Conduct Authority [FSCA], is currently looking at options aimed at assisting living annuity policyholders as a matter of urgency,” Lightbody says. “Solutions would require an amendment by the Minister of Finance to Government Notice 290 issued under the Income Tax Act.”
Proving some sort of a solution, however, seems imperative.
“Treasury should make a concession and allow retirees to amend their income amounts out of cycle,” says Gradidge.
“The current crisis should hopefully trigger a broader review of annuity products so that retirees have options in future crises.”