Market crash a threat to many pensions
Many South African pensioners drawing an income from investments in a living annuity will find themselves on a path to financial ruin after the severe selloffs on local and international markets as the coronavirus hit.
In particular, younger retirees who started drawing an income of more than 4% of their savings may reach the maximum income drawdown sooner than expected unless they reduce their pensions as soon as possible, professionals in the pension industry say.
The problem is so severe that annuity providers have asked the Association of Savings & Investments to lobby the Financial Sector Conduct Authority and the South African Revenue Service to allow retirees to reduce their incomes immediately rather than waiting for their policy anniversaries.
Drawing at a higher level following a market downturn means you disinvest a larger portion of your savings and lock in losses because the money you draw does not have time to recover, says John Anderson, executive for investments, products and enablement at Alexander Forbes.
Andrew Davison, head of advice at Old Mutual Corporate Consultants, says the average balanced fund - a much-favoured investment for retirees - is down between 15% to 25% this month.
Marc Thomas, head of product development at Bridge Fund Managers, says the impact of recent market falls if you have a living annuity depends on your withdrawal rate, your age, what you are invested in and whether your near-term income needs are ring-fenced in a cash "bucket".
Thomas says retirees drawing a low 2.5% to 4% of their savings every year probably do not need to panic because their drawdowns will not have increased to dangerous levels. But people who were drawing 4% to 8% of their savings should check what their drawdown rates are now.
An 8% drawdown on savings that have a medium to high equity exposure (between 60% and 75%) could now be a 12% drawdown and this level of income may not be sustainable, especially if you are a younger retiree who potentially needs to draw an income for another 20 to 25 years.
However, if you are older, a higher drawdown may be of less concern - if you are, for example, 80 and drawing 7%, you have less to worry about than the person who is 65 and drawing 7%, says Thomas.
Davison says the later you are in retirement, the lower the value of your investments exposed to the market and hence the lower the impact of a market slump.
Anderson says people who retired five years ago have had poor returns on their local savings in multi-asset funds since then. They may have started drawing a pension equal to 6.5% of their savings, but they may already now be drawing more than 10% or 11% of their savings.
Retirees who suffer poor returns in the early years of their retirement are most at risk of what is known as a sequence of return risk.
But Anderson says retirees who retired 15 to 20 years ago and enjoyed good returns in the early years of their retirement - post-2003 and post-2009 - may also be financially exposed.
Anderson, Thomas and Davison all say the best defence is to reduce the amount you withdraw. If that is not possible, do not increase your income on your next anniversary, says Thomas.
Daniel Wessels, an independent financial adviser with Martin Eksteen Jordaan Wessels, previously tested different drawdown strategies in about 5,000 simulations and found that increasing your income annually but always keeping your drawdown below a certain percentage of your savings is most successful in securing future income.
Not all bad news
But pension professionals say it is not all bad news as bond yields are high, which means guaranteed or life annuities are offering higher income streams than before.
Anderson says guaranteed annuity rates have increased 22% since the beginning of the year and can give most pensioners, including many with high drawdown rates, a similar but sustainable income.
Wessels agrees that guaranteed annuities are currently attractive for retirees who are drawing rates above 6% or 7% of their capital. Switching to a guaranteed or life annuity means you do not have to worry how long the bear market lasts, he says.
Anderson has presented extensive research to the Actuarial Society of SA showing the benefits of using a combination of living annuities and guaranteed annuities.
Surveys show South African retirees want to secure their income, but they choose living annuities in the hope that unspent savings will create a legacy for their children. Actuarial studies show they often don't realise how they risk their future income - potentially costing their children money.
Anderson's research shows that blending living and life annuities optimises your goal to secure your basic income and allows you to invest some money more aggressively in a living annuity for a legacy.
Bridge Fund Managers advises its living annuitants to park what they plan to draw as income in the near term in a lower-risk income-earning "bucket", topped up from the income the rest of their investments earn.
Thomas says living annuitants who are invested in other managers' multi-asset funds could also attempt to "bucket" their near-term income needs by switching out of their lowest-risk fund into cash enough to provide a secure income for the next two years. This will protect one's income from further losses in the markets and increase one's investment risk in the remainder of one's portfolio slightly, which should hopefully benefit one when markets recover again, he says.
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