Self-insure against the real 'risk' of a long life
Retirees using investment-linked living annuities who cannot afford to provide a pension for 30 to 40 years should take out insurance against longevity in the form of a guaranteed annuity. This is what one of the country's largest asset managers told the South African Independent Financial Advisers Association conference this week.
A couple both aged 65 are expected to survive 23 years, but 50% of people will outlive the average life expectancy, says Shaun Duddy, head of product development at Allan Gray. It makes more sense to provide for an income for a period after which there is only a 10% chance you will be alive. A couple aged 65 must plan for 32 years, Duddy says.
For a living annuity to provide an income starting at 4% of your capital, and increasing by inflation each year for 30 years, you need to earn a real (after-inflation) after-fees return of 2.2%, he says. If you are drawing an income at a higher rate, starting at, for example, 7%, you will need a higher real return - 6.8% from your investments.
Over the long term since 1900, equities have delivered a real (after-inflation) return of 7%, or 5.5% after fees of 1.5%. A real return of more than 5.5% without investment risk that could make your income unsustainable is probably not achievable, Duddy says.
He also warned that the order or sequence in which you earn returns when you are drawing an income regularly could make a targeted real return unachievable.
When returns are very volatile, it can cost you up to 2.5 percentage points on the average annual return over 30 years, he says.
Jaco van Tonder, head of adviser services at Investec Asset Management, says Investec has calculated that lowering the volatility of an investment as measured by standard deviation by three percentage points can increase your drawable income by one percentage point. He says even if you draw a low level of your capital as a pension, you need high exposure to equities and listed property; 60% should be in equities, half of which should be offshore.
Allan Gray's research shows at least 50% must be in equities to sustain a pension withdrawal of 4% of your capital.
Duddy says that if you can't afford to self-insure against the risk of a long life, you must insure your life.
Taking out a guaranteed annuity works because you pool your life with others. The insurer can plan for the average life expectancy and the investments of those who die earlier fund those who live longer.
Just CEO Deane Moore says blending living annuities with guaranteed or life annuities coveringbasic living expenses can enable you to draw a higher income than a living annuity can provide.
Duddy says that if, for example, you need an income of 6% of your savings, you can achieve this with 50% of your capital in the guaranteed annuity that delivers an income of 8%, and 50% in a living annuity from which you draw an income equal to 4%. The price of making sure your income lasts for 30 to 40 years is 50% of your capital, he says.