WARREN INGRAM: How to add more life to your living annuity
The Treasury is helping retirees and other investors in these tough times by increasing the interest you can earn from retail savings bonds
Markets around the world have taken a beating. This is concerning for everyone, but it is most problematic for retirees and others who require income from their investments. Aside from the stress of watching their capital diminishing at a rapid rate, retirees are understandably worried about how they are going to maintain their income in the future.
So what should you, as a retiree, do to balance your need for income while preserving the value of your capital?
Living annuities and market crashes
I am a big fan of living annuities. I think they are great if you are in a healthy financial position and are able to make rational decisions about your investments and the amount of income that you draw on an annual basis.
However, living annuities can be dangerous if you’re not in a healthy financial position. As a living annuity member, if you are financially compromised, a big market crash is devastating to your financial wellbeing.
You will need to make some difficult decisions as you try to balance the need to maintain your income while preserving your capital.
To compound the problem for retirees, SA interest rates have dropped by more than 20% in a short period. In addition, the lockdown has been particularly devastating to listed property companies. It is probable that they will reduce their dividends by a large percentage as their tenants are unable or unwilling to pay their rent in full.
As an aside, low-income retirees will suffer the most from the blatant profiteering by certain retailers that are thriving during lockdown but are still refusing to pay full rent.
Many retirees with living annuities are therefore in a tough position. At each anniversary of your living annuity, if you try to maintain the value of what you draw on a monthly basis, you will have to increase the percentage you take from your money.
If the percentage gets too high, you will permanently erode the value of your capital. For example, if you draw 15% from your investments every year, it is unlikely that the markets will grow by this rate every year into the future. That means you will be drawing more income at a faster rate than the capital will grow. If we include the effect of inflation over time, it is likely that the buying power of these living annuities will be halved within five years.
What to do?
It is worth repeating that this is a very difficult situation with no easy solutions. Retirees will have to balance the need to sustain a liveable lifestyle with the need to preserve capital for as long as possible.
If you are a retiree under the age of 75 who draws more than 10% a year from your investments, you need to reduce the risk of your investments, not increase the risk.
This seems counterintuitive as most people would try to solve this problem by increasing the risk of their investments with the aim of getting more capital growth.
Unfortunately, a high-growth portfolio is more prone to big losses in a market crash. The effect of the crash would be even more severe if you draw a large percentage of income.
To minimise the effect of a market crash, you, as an investor who draws a high percentage from your living annuity, should increase the amount invested in government bonds and cash. You will need to strike the balance between keeping some money in shares and listed property to get capital growth while earning as much income from cash and bonds as possible.
Updated temporary regulations
Thankfully for many living annuity members, regulations will soon be changed that govern how much living annuity members can withdraw from their investments. Members will be able to reduce the minimum amount to 0.5% a year.
In addition, members can increase the maximum amount of income to 20% a year. Initial indications are that these changes are designed to provide temporary relief and are likely to be reversed later in the year. Please keep watching correspondence from your living annuity provider as this is a developing situation.
Some good news
It is not all doom and gloom for living annuities. The stock market will recover and many of the listed property companies will get through this difficult time. That means share prices will rise, dividends will rise and rental income will increase one day. The critical point is not to sell all your shares and listed property — give yourself the best possible chance of participating in the recovery.
The Treasury has been hard at work helping retirees in these difficult times, increasing the rate of interest that people can earn from RSA retail savings bonds. These investments are similar to fixed deposits at a bank, except that the interest rate is guaranteed by the government.
They now offer an interest rate of 11.5% a year for five years, 9% a year for three years and 7.75% for two years. If you are a retiree over 60, you can opt for the interest to be paid to you on a monthly basis.
If you are under 60, your interest will be paid out twice a year or it can be added to your capital amount and paid out at the end of the fixed term.
It is difficult to find a trustworthy product that guarantees an interest rate of 11.5% a year — well done to the Treasury for offering this to South Africans at no cost. For older people, there is the added benefit of income tax relief on interest.
I would suggest that the Treasury makes available a product that offers interest at 10% a year, tax free to all SA citizens. It would be beneficial to the country (now that we have been downgraded) and would offer smaller investors a wonderful opportunity to grow their wealth in a safe manner.
If you want to know more, visit the website: www.rsaretailbonds.gov.za