Many pensioners who rely on investment-linked living annuities (illas) for an income are still in danger of outliving their capital, and could face destitution.
The latest figures released by financial services industry organisation the Association for Savings & Investment SA (Asisa) show that illa pensioners withdrew, on average, 6.77 percent of their capital as an income in 2012. Although this is lower than the average drawdown of 6.99 percent in 2011, it is still above the recommended initial drawdown rate of five percent or less of the annual capital value – the percentage that is targeted by Asisa.
Drawdown rates may be affected by anticipated longevity. Older pensioners can, potentially, draw down a sustainable income at a rate above the five percent or less that is recommended for pensioners aged 65.
Peter Dempsey, deputy chief executive of Asisa, says it is important to note that costs were excluded from the drawdown percentages. (Costs, including commissions, can total another two percent or more of cash outflows.)
“We only took into consideration drawdown percentages selected by policyholders. Costs were excluded, since these vary from company to company, and the advice fee is negotiable between the client and the adviser,” Dempsey says.
By law, illa pensioners must draw an income of between 2.5 percent and 17.5 percent of their capital value if the policy was bought on or after February 21, 2007. If they bought the policy before that date, the drawdown must be between five percent and 20 percent, unless drawdown changes were made to the illa since February 2007, in which case the new percentage range applies.
Drawdowns can be reviewed once a year on the anniversary date of the policy.
Dempsey says the survey enables Asisa to monitor the levels of income that policyholders draw from their retirement capital, as well as the asset composition of illa investment portfolios.
The survey “shows that the risk of living annuity policyholders eroding their capital too quickly by drawing too much income is not as high as previously thought.
“However, the current average drawdown levels of 6.77 percent, combined with costs and inappropriate asset composition, still put the policyholder at risk of eroding capital too quickly in real terms should drawdown rates exceed expected returns,” Dempsey says.
Fortunately for policyholders, the value of the average monthly drawdown increased by 10 percent, from R3 352 in 2011 to R3 690 in 2012, even though the percentage drawdown rate declined slightly. “This clearly reflects an overall net increase in asset values of more than 10 percent over the year,” Dempsey says.
For the sake of their financial security, illa pensioners should consider adhering to the prudential investment guidelines for retirement funds, even though this is not a legal requirement, he says.
The Asisa survey shows that 18.6 percent of policies did not comply with the association’s recommended asset composition, which is based on regulation 28 of the Pension Funds Act. The recommended maximum exposures to each asset class include 75 percent in the case of equities, 25 percent for property and 25 percent for offshore assets.
The survey results show that, on average, illa pensioners with larger asset values tend to apply drawdowns of less than 7.5 percent, and as the drawdown percentages increase, the average asset values progressively decrease. This is true for all age bands (see table, link below).
Dempsey says: “Unfortunately, consumers who have not saved enough for their retirement often turn to living annuities for the wrong reason. Being able to draw a higher income from an illa than would be available from a traditional compulsory annuity may help someone who does not have enough retirement capital to maintain a certain lifestyle in the early years. But hardship will follow when the capital has been depleted over a short period of time.”
Policyholders who are assisted by a financial adviser generally select lower drawdown rates, because they better understand the long-term implications, he says.
Other reasons that pensioners opt for higher drawdown levels are:
* Wealthier pensioners who have other sources of income can afford to draw down their capital faster than lower-income people and maintain their standard of living;
* Less wealthy people may have a poorer understanding of the dynamics of living annuities; and
* Legislation makes it difficult to consolidate several living annuities, so some pensioners may be drawing down larger amounts in order to close down smaller illas.
MORE INVEST IN LIVING ANNUITIES
Peter Dempsey, deputy chief executive of the Association for Savings & Investment of SA (Asisa), says the latest living annuity survey shows that:
* R191.2 billion in retirement savings were invested in some 305 145 living annuities last year. In 2011, some 278 000 living annuities held assets of R155.2 billion.
* Living annuities attracted new inflows of R27.1 billion in 2012, compared with R23.9 billion in 2011.
* In terms of Asisa’s Standard on Living Annuities, which came into effect in 2010, companies that belong to Asisa must provide a status report to the association at the end of each year. All Asisa member companies that offer living annuities had complied with this requirement at the end of 2012.