Tough decade lies ahead for pensioners
Asset managers warn retirees that returns will be below average
The decade ahead will be the most difficult yet for South African pensioners drawing an income from their investments, asset managers told independent financial advisers at a conference this week.
Returns would be below average for the next 10 years and retirees had never experienced this before, Lourens Coetzee, an investment professional at Marriott, told South African Independent Financial Advisers Association conferences that were held around the country.
He said low economic growth and the high debt-to-GDP ratio would result in returns being lower than they had been historically, and most probably below inflation plus 5.8%.
Bernard van Wyk, an investment consultant at Analytics, told the conferences there was a very high probability of lower returns in the decade ahead.
He is expecting the multi-asset funds typically used by investors drawing an income from a living annuity to deliver returns two to three percentage points below what they have delivered over the past 17 years.
Less is more
Coetzee and Shaun Duddy, the head of product development at Allan Gray, said the only way retirees drawing an income from investments in a living annuity could ensure their income was sustainable over a long period in retirement was to draw less than 4%.
Coetzee said Marriott tested the sustainability of income drawn at starting levels of 4%, 5%, 6% and 7% of capital a year for investments in different retirement periods since 1950, a total of 88 30-year retirement periods.
An asset allocation of 60% in equities, 30% in bonds and 10% in cash was assumed and average returns for these asset classes measured since 1900 were used. Marriott also assumed that retirees would increase their income by inflation each year.
Marriott found that if retirees drew an income starting at 4% of capital, the income was not sustainable in only 6% of the 88 periods.
If the starting income was increased to 5%, the failure rate increased to 27%. At an initial drawdown of 6%, the failure rate increased to 47% and at a 7% initial income it reached 64%.
Coetzee said the income was regarded as unsustainable when it breached the maximum level at which a pension could by law be drawn from a living annuity - 17.5% a year. At this level, an income can no longer increase to keep pace with inflation and may even decline in nominal terms as well.
These income withdrawal rates are before fees, and Marriott said that if these amounted to 1.5%, your income drawn at 4% a year would be reduced to 2.5% of your retirement savings a year.
10 years is the likely period over which returns for retirees will be below average
First decade is key
Coetzee said the actual amount you can draw from your retirement savings as a pension depended on what returns you earned during retirement - it could be as high as 15% in some periods. The returns in your first decade of retirement were the most important in determining what you could draw, he said.
Marriott looked at the retirees who earned returns of less than inflation plus 5.8% - the kind of returns you can expect in the decade ahead - and found the numbers got "quite scary", Coetzee said.
At a starting pension drawn at a rate of 2.5% of capital, 10% of them found their income was not sustainable, and at a rate of 3.5%, 49% of them failed. Higher income failure rates were achieved (82% and 98%) when the initial pension withdrawn was 4.5% or 5.5%, Coetzee said.
Marriott's investment style focused on producing "a reliable and growing income" and Coetzee said drawing only the amount your investments produced could ensure your capital would always deliver a sustainable income.
Expect 10% from equities
Van Wyk said the average return from equities since 1960 had been almost 18% a year, but the current price-to-earnings ratio for equities - which gives an indication of the earnings you can expect for every R1 of share price - was now almost 20 for the JSE.
He said this meant you could expect a nominal return of 10% a year from equities.
Similarly, bonds, which have returned on average 12.2% a year since 1960, were only likely to earn 8.6%, in line with the 10-year bond yields, Van Wyk said.
If multi-asset funds delivered returns two to three percentage points lower than they had over the past 17 years, a typical investor retiring at age 60, drawing an income at a rate of 6.6% of capital and increasing this by inflation each year, would only be able to sustain his or her income at that level for 12 years, he said.
At that point, the retiree would reach the maximum withdrawal level of 17.5% a year, Van Wyk said.
Lower costs possible
If your living annuity was invested in a medium equity fund with some 50% exposure to equities, you could expect your income to increase with inflation for 13 years, and in a high equity fund you could expect 14 years, Van Wyk said.
Living annuity investors could consider a 100% equity investment because they did not have to comply with the prudential investment guidelines in regulation 28 of the Pension Funds Act, he said.
Some investment platforms now give you the option to invest directly in share portfolios and Van Wyk said these could be tailored for lower costs and to focus on high-dividend-yielding shares.
Those who are safe
Living annuities used by nine out of 10 retirees to provide a pension are safe products for those who can draw less than 5% of their capital at retirement, Jaco van Tonder, the head of adviser services at Investec Asset Management, told the South African Independent Financial Advisers Association conference this week.
Retirees who need to draw more than 10% of their capital as a pension are likely to find that the income they can draw from a living annuity will reduce within the first decade, he said.
Retirees who need to draw between 5% and 10% of their capital need to spread their risk of outliving the ability of the capital to provide an income for a potential 30 years in retirement. If you are drawing an income at this level you do not have enough to hedge your own risk of living a long time and you should consider insuring some of your income by taking a guaranteed or life annuity from a life assurer, Van Tonder said.
Guaranteed annuities pay an income for life regardless of how long you live, but there is typically no remaining capital for your heirs on your death.
Van Tonder said on Investec's investment platform between 50% and 60% of living annuitants are drawing an income that is sustainable, 30% need to be very careful and 10% are likely to run out of money in the near future.
This excluded those who invested less than R1-million and are probably using the annuity to top up other pension sources.