How to handle changes to living annuity drawdowns
Take advice about what the hotly anticipated tweaks to the legislation will mean for the longevity of your income
Retirees are likely to be able to adjust the percentage they draw as a pension from their savings in an investment-linked living annuity at the end of May until the end of August.
Life companies and investment platforms are on tenterhooks expecting changes to the relevant legislation to be gazetted any day now, but are preparing to allow living annuitants to make changes in time for pension payments that start on the 24th of the month.
Finance minister Tito Mboweni has proposed that living annuitants be able to change the amount they draw as pension from their retirement savings for four months between May and August. Proposals are that they be able to draw anything between 0.5% and 20% of their savings instead of anything between 2.5% and 17.5% of their savings.
“This is a temporary measure to assist individuals who either need cash flow immediately or who do not want to be forced to sell after their investments have underperformed,” says Wynand Gouws, a financial adviser with Gradidge Mahura Investments.
While retirees await the final details of the change, they should start getting advice, financial advisers say.
Gouws recommends all pensioners — except those facing a crisis as a result of the lockdown — consider reducing the amount they draw as a pension, known as their drawdown rate.
Ordinarily, pensioners choose how much they want to draw as a pension on the anniversary of their policy each year and that rand amount is paid for the rest of the year. If the markets fall after a living annuitant has made his or her selection, the percentage drawn increases.
When the proposed changes are gazetted it is expected that annuitants will be able to change their drawdown rate immediately instead of waiting until the anniversary date of their policy. This will mitigate the risk that comes with regular withdrawals when the capital value is down — as it will be now after large falls in global and local financial markets.
If you continue to draw high percentages on your depleted capital, the percentage drawn can quickly escalate until it reaches the maximum you are allowed to draw.
See if you can reduce your expenses or earn some extra income, so that you can draw a lower pension and relieve the stress on your annuityWynand Gouws, financial planner at Gradidge Mahura
At that point — known as the point of ruin — you can no longer increase your pension each year to keep up with inflation, resulting in your income declining in real (after-inflation) terms.
John Anderson, the executive for investments, products and enablement at Alexander Forbes, says its calculations show that changing your drawdown rate for four months could hasten or delay your point of ruin by a month or two, depending on whether you increase or decrease your pension and whether the change is one to two percentage points.
You can have more of an impact on the sustainability of your pension if you adjust your drawdowns permanently at your next anniversary, he says.
If you are drawing around 6.5% of your capital – about the average drawdown according to the latest industry statistics - and increase your drawdown rate by one percentage point permanently, you are likely to reach the point of ruin between two and three years sooner.
Gouw says if you retire at age 65 and start drawing 6.5% of your savings, which you increase by inflation each year, you will, assuming average returns, start eroding your capital in 13 years’ time and at the current drawdown levels your income will start reducing from age 86, he says.
This may fall short of many people’s life expectancies, as there is a high probability that one spouse in each couple retiring at age 65 will need to fund a pension for 30 years — to age 95.
Gouws says if you reduce your income to 5.5%, you can delay eating into your capital until 24 years after your retirement. This means your income will continue increasing for 30 years, until age 95.
Pensioners who need to increase their income over the next four months should do so with care.
Anderson says anyone who is drawing 17.5% of their annuity and ups this to 20% will probably reach the point of ruin within a year.
Gouws says you should only be drawing 17.5% or more if you are of ill health or are intentionally running down a low savings amount in a living annuity to a level where you can cash out.
Darryl Welsh, head of product for Ninety One’s investment platform, says that because many annuities will pay out from the 24th, annuitants will need to send instructions to increase or decrease their pensions as soon as the changes are gazetted.
Some annuitants may miss the deadline to change their pensions for May and providers are therefore hoping that the final changes will allow greater flexibility on when annuitants can implement the changes.
In its comments on the proposed changes, the Financial Planning Institute of SA (FPI) suggested that the lower drawdown rate of 0.5% should be retained indefinitely, as an extended period of low market returns is expected. It is not clear if this proposal will be accepted.
This will assist retirees who are working beyond their formal employment but retired before it was possible to defer drawing an income from their retirement savings, says David Kop, the FPI executive for relevance.
Anderson says if you reduce your drawdown to 0.5%, you will probably never reach the “point of ruin” as you will most likely earn returns of more than 0.5% above inflation.
The FPI has recommended that annuitants be allowed to change their drawdown rates for more than just four months. It suggests changes selected now remain in place until the pensioners’ policy anniversary after August 31 2020 unless annuitants opt out of the new drawdown rate by August 1.
Kop says the need for advice should not be underestimated and this arrangement would ease the administration burden on annuity providers.
Welsh says providers now have the technology to change drawdown rates at any time. He hopes the expanded limits are implemented for longer.
Mboweni has also proposed that living annuitants be able to withdraw all their capital from living annuities when the value falls below R125,000 as it is often too expensive to maintain small amounts. Now, you can only encash an annuity if the value falls to R75,000 or R50,000 if you have already taken a lump sum from your annuity. This new limit is expected to be permanent.
Mitigating a pension reduction
Living annuitants who need to reduce the amount they draw from an investment-linked living annuity to preserve the savings that support their pensions may be able to offset the income loss by transferring all or some capital to a guaranteed life annuity.
Guaranteed life annuities, which guarantee an income for life, will typically give you a higher income than the sustainable income level you can draw from a living annuity because life annuities are priced to run your capital to zero, whereas in a living annuity you need to maintain a relatively high level of capital to generate the income you need, Wynand Gouws, a financial planner at Gradidge Mahura Investment, says.
The income from guaranteed life annuities spiked with bond yields after the crash before reducing a bit, but remain attractive.
Belinda Sullivan, principal consultant at Alexander Forbes, told members in a webinar on Friday that lower guaranteed life annuity rates — rates at which you can buy an income with your capital — meant that despite the fall in the markets, a 30-year-old can get 10% more income than before the market crashed in February, a 45-year-old can get 6% more and a 64-year-old can increase their income by 0.4%.
Gouws says if a guaranteed life annuity can secure an income for life that is two percentage points higher than what you can safely draw from a living annuity, you can increase your income by 20%.
Living annuitants should maintain exposure to the right asset classes, as there is a tendency for people to want to move into more conservative asset classes like cash when markets fall, Gouws says. This would lock in paper losses on investments such as equities and prevent you from enjoying any recovery in the market, and interest rate cuts have reduced cash returns by two percentage points.
Gouws says if you move to cash and draw an income of 6.5% of your savings, you will start eating into your capital in a year. “This is a disaster and in 11 to 12 years, your capital would have halved and you will reach the 17.5% cap.”