Give your retirement income legs rather than aiming for a jackpot
No product can save you if you have not saved enough
Retirement fund members who need to use their retirement savings to generate a pension should focus on ensuring the income is sustainable rather than chasing the highest income or the best returns.
The latest thinking on providing an income in retirement recognises the need to minimise the risks of an “income crash” due to the effects of longevity, investment risks and inflation.
Managing your retirement cash flow can add much more value than trying to find the highest starting value without knowing whether it will be sustainable, Ryno Oosthuizen, business development manager at Glacier by Sanlam, told a recent Glacier seminar.
Oosthuizen says if you have not saved enough, no product can save you. Sanlam’s Benchmark Survey shows the average retirement fund member’s savings are likely to generate an income that will replace just 38% of their pre-retirement income.
Faced with not having saved enough, many people use an investment-linked living annuity, hoping they will earn good returns on their capital that will save them from having saved too little.
But a good adviser should do damage control and tell you what your savings can safely generate, Oosthuizen says. Poor returns put retirees at a much greater risk than those who are saving for retirement.
Duggan Matthews, an investment professional at Marriott, told advisers at the Collaborative Exchange’s Meet the Managers events earlier in 2019 that asset managers tell investors that investing is about the long term and they should not worry about years of poor returns as the good returns will follow, but this answer is only appropriate pre-retirement.
Investors drawing a regular pension when their savings are delivering poor returns are at risk of being left with too little capital to recover when the good returns come back.
Matthews says this is a major concern for living-annuity investors who have experienced poor returns from multi-asset or balanced funds over the past four years.
A retiree who invested R1m in a living annuity at the end of 2014, earning the average returns earned from SA’s high-equity multi-asset funds and drawing a pension in line with the average living annuity withdrawal of about 6% with a 6% increase each year, could already have had a 12% decline in capital to R885,000, he says.
After starting to withdraw an income equal to 6% of his or her capital, that withdrawal would now be close to 9% of the retiree’s savings, Matthews says. The maximum you can draw is 17.5%, at which point the buying power of your income will reduce each year. Allowing the percentage of your capital you withdraw to rise steadily therefore puts the sustainability of your income at risk.
There is a 50% chance that one spouse in every couple aged 65 will live to age 94, which means retirees need to plan for their investments to last for 30 years.Ryno Oosthuizen, business development manager at Glacier by Sanlam
Investors who need to draw an income from their savings have different needs to those investors who are saving for retirement and they cannot be served in a single portfolio as there are different dynamics at play, Matthews says.
Marriott’s solution is funds that focus on generating income so investors can draw only the income generated and not draw from the capital that generates that income.
Its latest fund, the Essential Income Fund, is aimed at producing an annual income of about 6% of your savings with the income, also growing at 4% to 6% to keep up with inflation.
The fund is designed to do this by investing in the optimal mix of blue-chip shares that pay stable dividends, high-income bonds and listed property.
A number of managers have income-focused funds and some like Marriott and Bridge Fund Managers offer funds with different combinations of income and growth. Typically the higher the income generated, the lower the future growth on that income.
In these investments, however, your savings values may fluctuate and some retirees find this difficult to stomach.
Another solution living-annuity providers have come up with is to invest a portion of members’ living-annuity savings in an underlying investment that works like a with-profit annuity, guaranteeing some income that grows in line with investment returns.
Oosthuizen says there is a 50% chance that one spouse in every couple aged 65 will live to age 94, which means retirees need to plan for their investments to last for 30 years. Ensuring your capital lasts for that long typically means reducing the percentage of the capital you withdraw.
Retirees using Glacier by Sanlam’s living annuity can invest in units in the Investment-Linked Lifetime Income plan that provides an income at with-profits annuity rates and income growth dependent on the underlying investment you choose.
Oosthuizen says scenario testing shows using these units for a portion of your living-annuity investment can increase the period for which your income is sustainable. Adding a guaranteed annuity to the mix can also be beneficial, with the guaranteed income making up any decline in income arising from the depletion of capital in the living annuity.
Similar to Glacier’s product is Just’s Lifetime Income portfolio that is now available to those using living annuities on Sygnia and Alexander Forbes’s investment platforms, and being piloted on Allan Gray’s. Just SA’s CEO Deane Moore says it is likely to roll out on other platforms in 2020.
Like Glacier’s offering, you buy units in a with-profits annuity that provides you with a guaranteed income that can continue until your surviving spouse dies or can be guaranteed to pay for a certain period irrespective of whether you survive for the full period.
The income growth is linked to an underlying investment in a leading multi-asset fund, or funds, on the platform.
Moore says that over a 30-year retirement planning horizon, Just Lifetime Income provides a return of 2.5% a year above the investment performance of the underlying balanced fund. The reason for this is that you pool your income with that of other retirees, some of whom will die before the others. The dividend from those who die before you ensures you a higher income, he says.
Units in Just’s Lifetime Income product can be transferred across the platforms of the living-annuity providers who offer it.
The Financial Sector Conduct Authority has also agreed to allow Just's Lifetime Income portfolio to be used in default living annuities offered by employer-sponsored retirement funds and RAs by exempting it from the requirement that underlying investments must be fully realisable.
Members of defined-contribution pension and retirement annuities must use at least two-thirds of the savings to buy a pension or annuity at retirement.
You can buy:
- A living annuity in which you choose the investments but take the risk that your savings will be sufficient to provide you with the income you need. You must draw between 2.5% and 17.5% of your capital each year. Your heirs can inherit any capital left when you (or you and your spouse) die.
- A guaranteed life annuity guarantees you a pension for as long as you live. You can opt for an annuity that pays for as long as you or your spouse live or you can take out a guarantee that the annuity will pay for a certain period, such as 10 years, regardless of whether you live. These options lower your starting pension.
You can choose a guaranteed life annuity with no increases (level), with a set or inflation-linked increase (escalating) or a with-profits annuity in which increases are related to investment returns.
With a guaranteed life annuity, the annuity is guaranteed for your life or the relevant period but there is no remaining capital to leave to your heirs.