| If you’ve been following my posts, you’ll know that I talk extensively about that ‘event’ called retirement – which is changing in its time frame and duration all the time. These changes started over two decades ago when pensions, in the main, stopped being ‘defined benefit’ (DB) and turned into ‘defined contribution’ (DC) funds. In other words (and many of you boomers will remember this) your pension went from being a multiple of the number of years you’d worked multiplied by your end salary – to how much you and your company contributed to the fund. In the bad old days when you left a company and ‘preserved’ your pension, you had to leave your company contributions behind (that was all changed, and by the early 2000s you could go back and reclaim those contributions.) At the time ‘life annuities’ (pre about 1996) were the norm – in other words you got a set pension (perhaps increasing with inflation and maybe passing on to your spouse) but in the end on the second of the spousal unit to die there was nothing left behind. There are still large companies and parastatals today who default to ‘life-annuities’ (if you don’t inform them timeously of your preference.) This (live but lose it) annuity environment changed with living annuities that we are much more familiar with today. Managed properly and drawn-down on prudently (advice-speak for not taking too much) that ‘pension’ can not only produce an income that grows annually and never runs out no matter how long you live, but the capital (which is probably much more than you started with) can be left as a legacy. I am going into this mini-history lesson on purpose… These changes from DB pensions to DC pensions introduced a whole new level of uncertainty that most laypersons were unfamiliar with and, frankly, brokers giving advice to retirees were also not particularly adept at navigating. Living annuities brought a second layer of uncertainty to the equation. No longer would pensioners be forced to take pensions according to a set formula published by life companies weekly – but they could choose to take anything between 2.5%-17.5% of the capital per annum (remember the prudent level is somewhere between 4-5%). When I came into this industry almost two decades ago it was assumed that retirees would live 20 years post-retirement, so the recommendation that we were ‘taught’ was to deplete the capital over twenty years. Nobody seemed to factor in the very real problem of longevity and this has been on a one-way track to living to a hundred for decades now, and you can see in the graph below that in the West and Oceania the AVERAGE life expectancy is already 80 years old, which means that those retirees who bought into the ‘capital depletion over twenty years’ notion are now running out of funding. (The dip you see at the end of the graph was Covid – for all those conspiracy theorists out there who think it was a non-event). Source: Our World In Data. The uncomfortable truth, which I still run up against today, is that ‘prudent’ income drawdown rates result in a much lower ‘pension’ than a client is expecting. When a client’s expectations are not met it can be a stressful situation, and often results in a client ‘shopping around’ for a better income (and they will find it, but the capital depletion time-bomb will be buried in the small print) While life annuities are not as popular as they were two decades ago, they still exist, and I have used them once or twice in my career (for clients who have no spouse or dependents and no desire or capacity to worry about ongoing input and maintenance). You can always get the latest rates from Masthead https://www.masthead.co.za/annuity-investment-rates/, but let’s look at the least-worst option (IMHO) you can get on a life annuity – remember this is NEVER my first choice. What you want from a pension is a stable income that grows with inflation annually and never runs out. Just for simplicity, let’s assume it’s for one person and there is no spouse. In a LIFE annuity this equates to about R6,400pm per R1m today – that is a 7,6%pa draw down on the capital. That is way above the high end of the 5% drawdown (R4,166 per R1m) rate recommended in a LIVING annuity. The difference? In a life annuity when you die, whenever you die, that capital is gone. In a living annuity the capital (with the growth) is still there for your beneficiaries if managed properly. (Here’s an unpopular suggestion, if you really want to leave a legacy (and not have your decedents cash the pension in on your death (with your estate paying the tax), and have some control beyond the grave, you can leave this to an Inter Vivos Trust (that you form while you are alive) with the instruction to pay your beneficiaries that income, and maybe even their decedents too). Yes, there are ‘hybrid’ solutions to this life-or-living annuity option, none of which I have ever been tempted by as an option, and at any time you can convert the Living Annuity to a Life annuity (but not visa versa). Where does this ‘prudent’ drawdown rate come from? If you want the income you draw from an investment to grow with inflation and never run out then you are going to have to make sure the capital in the portfolio grows. Putting equities in there will certainly do the trick, over long periods of time they grow at least CPI (say 5%) plus 5%. In other words, they have a real or inflation adjusted growth of 5%. Unfortunately, equities go up AND down, sometimes down as much as 30%. If you have a pure equity portfolio and you continue to draw down on the income while the market is tanking – you can put an irrevocable hole in the capital. You could reduce your income to the dividend yield – but that is going to cut the income by half or two thirds. Other assets (bonds, money-market, fixed income) though continue to yield even when markets tank (and often increase in yield at those times) and can buffer the downside. At the moment, bonds are yielding in the 8-10% range – or CPI plus 3-5%. So why not put everything in fixed income? Because that capital doesn’t grow UNLESS you plow some of it back (probably up to half). If the capital doesn’t grow, the income can’t grow annually with inflation either – and we all know that what we can get with R100 today is nowhere near what we can get with it in 7 years’ time (actually, in RSA that is about the ‘half-life’ of that R100 thanks to inflation). So, you’re paying yourself 4% – again. Within a ‘balanced’ unit trust they will do the rebalancing of the asset classes for you – but it is still going to depend on you drawing down a prudent rate. If you stick to that simple rule, you’ll probably be alright but be very careful of the fees you’re paying. You can see that once you understand how your pension will actually work, you can start aligning your expectations with reality. Unfortunately there are still brokers out there who will match the income expectations of a retiree – but when it runs out and the assumptions made in coming to that ‘better’ income will be buried in the small print. Frankly, I never wanted to be in a position where I sit down with a retiree in the 80s, who had insisted on a ‘better’ pension, and tell him or her that the funds were running out – and which of their kids they were going to move in with. In some instances, selling their home and renting will eke out a few more years, but that too will eventually run out. If you’ve got the luxury of some time before retirement – you have got time to make sure your income meets you expectations (even if it’s going to be lowering your expectations). If you haven’t, then play some catch up before you ‘retire from’ your investments – mistakes made at that crucial point often cannot be reversed and may have severe tax implications. Even if you think we planners and advisors are sharks – this is the time to find one to help. You may even be able to find someone who will do a retirement plan for a fee (before you ask, I don’t. I prefer to have long term investment relationships with my clients so that we can tweak the portfolio as life and markets change.) The more organized you are, and the more you understand your future expenses, the easier it will be to plan. My RedFile organizational system is still free on request and includes basic balance sheet and income statements for you to work with. My Will checklist has now been included in this. Articles and Blogs: Apportioning blame for your financial state NEW Tempering fear and greed NEW New Year’s resolutions over? Try a Wealth Bingo Card instead. Wills and Estate Planning (comprehensive 3 in one post) Pre-retirement – The make-or-break moments Some unconventional thoughts on wealth and risk management Wealth creation is a balancing act over time Wealth traps waiting for unsuspecting entrepreneurs Two Pot pension system demystified Keeping your legacy shining bright Financial well-being when dealing with Dementia and Alzheimers Weathering the storm Pruning your wealth farm Should you change your investments with changing politics? Taking a holistic view of your wealth Why do I need a financial advisor? Costs Fees and Commissions The NHI and what to do about it New-Normal for Retirement? Locking-In Interest rates – The inflation story Situs – The Myths and Reality Tax Residency – New Rules new headaches Are retirement annuities dead A new look at retirement Offshore investing – an unpopular opinion Cobie Legrange and Dawn Ridler, Rexsolom Invest, Licensed FSP 45521. Email: cobie@rexsolom.co.za, dawn@rexsolom.co.za Website: rexsolom.co.za, wealthecology.co.za |
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