Living annuity annual review: What to check before your policy anniversary date

Building blocks to a lasting Living Annuity

Our panel of experts discusses living annuities, sustainable drawdown rates, offshore investing, and everything else one might need to consider to ensure a comfortable retirement. Read more

A living annuity provides retirees with flexibility, but it also requires responsibility. Regular reviews are crucial to keep it aligned with your financial needs. As your circumstances, income requirements, fees, inflation, and market conditions may change annually, it's vital to review your annuity on the policy anniversary each year. During this review, you might need to adjust your drawdown rate and fund choices. This article takes a closer look at fund selection, fees, drawdown rate, inflation, beneficiaries, and how 10X can assist you during the review process.

What is a living annuity policy anniversary date?

Your policy anniversary date is the annual anniversary of the date on which your living annuity first started. This is the date by which any changes to your drawdown rate must be submitted each year, so they can be actioned for the following year.

Your drawdown rate is the percentage of the total value of your annuity that you withdraw as income each year. Your drawdown rate can be between 2.5% and 17.5% per annum. It’s important to check that your current drawdown rate remains well aligned with your financial needs and long-term retirement plan and goals.

Why annual living annuity reviews matter

As mentioned, you have flexibility in your drawdown rate and in the underlying funds in which your capital is invested. You will withdraw income from your annuity while the capital stays invested in the market, so careful management is essential. It must support your income withdrawals, fees, inflation, and market fluctuations. When reviewing your annuity, there are some risks that you would want to consider. Let’s have a look at some of these:

• Longevity risk: This is the risk that you outlive your living annuity capital. You would want to ensure that your selected drawdown rate is sustainable.
• Inflation risk: This is the risk that the increasing prices of goods and services will decrease the real value of your investments over time.
• Sequence-of-returns risk: Sequence-of-returns risk is the risk that you may receive poor returns at the beginning of your retirement years, which may then have an impact on your annuity’s long-term value.
• Behavioural risk: Emotional decision-making, panic switching or performance chasing may negatively impact your long-term financial plan.
• Drawdown risk: The risk that your selected income may be too high for the portfolio to grow or sustain itself.

An annual review allows you to take a holistic look at your living annuity and carefully consider whether any changes are needed, rather than reacting emotionally to short-term market activity.

Check #1: Is your drawdown rate still sustainable?

Your drawdown rate determines your annual income, with flexible payment schedules such as yearly, biannually, quarterly, or monthly, based on your preference. A lower rate allows more capital to remain invested for potential growth and compounding over time, while a higher rate may reduce the capital available for growth. This makes your drawdown rate one of the most important decisions to review before your policy anniversary date. The income you need today must be balanced against the income you may need in later retirement, especially as inflation, healthcare costs and market performance can all affect the long-term value of your annuity.

As noted, you can choose a drawdown rate between 2.5% and 17.5% annually. It’s crucial to select a sustainable rate to ensure your capital supports you throughout retirement. Many experts consider 4% a sustainable guideline, as research from William P. Bengen shows, but there are no guarantees. A guideline can be helpful, but it should not be treated as a fixed rule for every retiree. Your ideal drawdown rate will depend on your age, total retirement savings, other sources of income, investment returns, fees, inflation and how much flexibility you have in your monthly budget. Here are some important questions to consider when you are reviewing your drawdown rate:

1. Is your current income enough to meet your financial needs?
2. Have there been any lifestyle or cost of living changes?
3. Is your current drawdown rate sustainable?
4. Are you able to decrease your drawdown rate?
5. Has your portfolio performed better or worse than expected over the past year?
6. Have inflation or healthcare costs placed more pressure on your monthly budget?
7. Do you have other income sources that could reduce the amount you need to draw from your annuity?

If your current drawdown rate is placing too much pressure on your capital, your annual review may be a good opportunity to consider whether a lower income level is possible. Even a small reduction may help more of your capital remain invested, giving it more opportunity to potentially compound and grow over time to support your income needs over the longer term.

Check #2: Does your fund selection still match your needs?

Your living annuity's capital is invested in the market, making the choice of underlying funds a key factor. This capital forms the core of your investment within the annuity wrapper. Since your fund needs may evolve, it's important to regularly review and select funds that best suit your current goals.

At 10X, investors choose from a selection of carefully curated funds, each geared towards different investor profiles and invested in different asset mixes. Consider your investment timeline, risk tolerance, and long-term financial plans. Asset allocation involves dividing your investment across asset classes such as equities, bonds, property, cash, and offshore investments. This allocation significantly influences how your portfolio reacts to inflation, interest-rate shifts, and market changes. Research from Brinson, Singer and Beebower highlights the vital role of proper asset allocation.

We've built the 'happy retirement' machine

Understanding the most effective strategy for investing your retirement savings is fundamental to experiencing a happy retirement. We've built an investment machine that gives you a great chance of really golden years. Read more

Equities may be suitable where you are aiming for long-term capital growth and inflation-beating returns in your portfolio. Due to their potentially volatile nature, they are generally more appropriate for investors with longer time horizons and the ability to tolerate volatility.

Bonds, on the other hand, are usually more stable than equities. Bond values can be affected by changes in interest rates, inflation, and the issuer's ability to repay its debt. They are considered more conservative than equities and real estate, but they may still outperform expectations.

Real estate may be a good hedge against inflation. It may also contribute to long-term growth in your portfolio. However, listed property can be volatile and may be influenced by changes in the property market, economic conditions and more.

Cash is usually the most liquid and stable among asset classes. You may expect lower returns, and returns may struggle to outpace inflation. This may, in turn, affect the purchasing power of your money. Including offshore assets in your portfolio may improve diversification and increase exposure to a broader range of economies. It may come with its risks, such as those associated with global markets and currency fluctuations.

Living annuities are not subject to Regulation 28, which may give you more flexibility, as there are no limits to how much you are allowed to invest offshore and in equities. As an investor with 10X, you are able to choose from a range of carefully curated funds that are well-diversified. Please visit our funds page to learn more.

Check #3: Are your fees still reasonable?

You should aim to review your fees each year. Fees should be transparent and cost-effective. Fees can affect the potential growth of your capital over time, and keeping them low is important even during retirement, when you will be drawing an income from your capital. You may find that high fees leave fewer returns available to reinvest, whilst lower fees may mean you have more capital available to grow over time. Take a look at this article covering the maths to learn more. Let’s look at an example to show the effect that fees may have on your living annuity. We will assume the following information:

• Starting capital: R3 million
• Investment period: 25 years
• Gross annual return: 10%
• Inflation: 5%
• Annual drawdown rate: 4% of the opening value each year

Scenario 1 - 1% Fees: After 25 years, the annuity would be estimated at around R4.9 million. (Inflation-adjusted value).

Scenario 2 - 3% Fees: After 25 years, the annuity would be estimated at around R4.4 million. (Inflation-adjusted value).

We can see how small differences in fees may lead to meaningful differences in retirement outcomes. The fee example is for illustrative purposes only and real results may vary. There are a few kinds of fees that you may see charged on your living annuity. These are as follows:

• Advisor fees: There will be fees charged by your advisor. You may see both an initial and an annual fee charged.
• Administration fees: These are the fees that are related to the administration of the fund. These will include tasks such as tax and compliance.
• Management fees: Fees that are charged for the running of the fund.

As an investor, you should also be aware of the following key terms:

• TER (Total Expense Ratio): Ongoing expenses within an investment fund, calculated according to the applicable standard. (A way to compare the operating costs of similar funds, but it is not the final cost)
• TIC (Total Investment Charge): The total investment charge, which combines the TER with transaction costs within the fund. (A way to compare the full cost of the investment portfolio itself)
• EAC (Effective Annual Cost): An annualised estimate of the impact of product, investment management advice, administration fees, and all other applicable charges.

The Effective Annual Cost (EAC) is a standardised metric used to compare the annual cost of different products. It was introduced by ASISA in 2015. Assuming all factors are kept equal, you may see a lower EAC mean that a larger portion of your capital remains invested and available to potentially earn returns. A higher EAC may result in less of your returns being reinvested and available to potentially grow and compound over time.

At 10X, you will find fees that are low-cost, simple and transparent. Please explore our product page to find out more about the product-specific fees. We also offer an EAC calculator, which is a part of our free online suite of tools that are available on our website. This calculator will help you to compare and evaluate the EAC of different service providers.

Check #4: Is your income keeping up with inflation?

Over time, prices for goods and services tend to rise, reducing what your income can buy each year. This phenomenon, known as inflation, diminishes the purchasing power of your money. This is particularly important in retirement because your annuity income may need to support you for many years. Even if your income feels sufficient today, the same amount may not cover the same expenses in future if prices continue to rise.

During your annual review, you should consider whether your income still matches your actual cost of living. This may include everyday expenses such as groceries, transport, utilities, insurance and healthcare. If these costs have increased meaningfully, you may need to review whether your current drawdown rate, fund selection and overall investment strategy are still appropriate.

The golden equation is a practical tool for assessing the sustainability of your living annuity. It is expressed as follows: Drawdown rate + fees + inflation ≤ investment returns.

If withdrawals, fees, and inflation consistently exceed the returns generated by the portfolio, you may see the real value of the capital decline. Ideally, you want your investment returns to exceed the sum of your drawdown rate, fees, and inflation. It’s important to remember that this is a planning guideline and not a guarantee.

The main point is that inflation should not be reviewed separately from the rest of your annuity. If your drawdown rate is too high, your fees are high, and inflation is placing pressure on your expenses, your portfolio may need stronger investment returns just to maintain its real value.

Check #5: Have your personal circumstances or beneficiaries changed?

When it comes to reviewing your annuity, you would also want to review who you have listed as beneficiaries on the policy. As circumstances can change, there may be a need to update your listed beneficiaries to ensure that they reflect your preferred estate plans. This may also be required after a major life event such as a marriage, death or divorce.

Your beneficiary nomination should reflect your current wishes, rather than decisions that may have been made years ago when your family or financial situation looked different. Changes such as the birth of a child or grandchild, the loss of a loved one, remarriage, separation or a change in financial dependants may all affect who you want to benefit from your remaining living annuity capital.

An attractive feature of living annuity capital is that it may be left to nominated beneficiaries. The beneficiary may then have the option to take a lump sum, a living annuity or a combination of both. This will be subject to tax and product rules.

This flexibility can make your living annuity an important part of your broader retirement and estate planning. However, it is still important to make sure your beneficiary details are accurate and up to date. Incorrect, outdated or incomplete beneficiary information may create unnecessary complications for your loved ones at a difficult time.

Your annual review is therefore a useful opportunity to check the practical details as well. Make sure the right people are listed, their details are correct, and your nomination still reflects your existing intentions.

How 10X can support your living annuity review

At 10X, we are able to offer a range of useful tools to help you when it comes to reviewing your living annuity. These form a part of our free online suite of tools available to you on our website. You may like to make use of the living annuity calculator or the EAC calculator to assist you when reviewing your annuity. These tools can help you look at your living annuity more practically before making changes.

You can expect an index-based investment approach that includes a diversified range of local and offshore funds. Our fees are clear, low-cost and easy for investors to understand. This is important during an annual review because fund selection and fees can both affect the long-term sustainability of your annuity. A diversified investment approach may help your capital remain exposed to different sources of return, while transparent fees make it easier to understand what you are paying and how those costs may affect your outcome.

You can also contact the efficient and experienced investment consultants at 10X at no additional cost. They are easily reachable by phone to assist with any queries or offer guidance. This support can be helpful if you want to better understand your drawdown options, available funds, fees or the tools on the 10X website before your policy anniversary date.

Final thoughts on living annuity reviews

A living annuity review is a valuable opportunity to assess whether your annuity still aligns with your current situation, needs and long-term financial goals. You should focus on your drawdown rate, fees, fund selection and beneficiary selection, as these may need to be adjusted to reflect any changes that have occurred.

Any changes to your drawdown rate should be made before your policy anniversary date, so aim to complete your annual review before then. If you are looking for guidance on your living annuity, don’t hesitate to get in touch with the skilled and approachable investment consultants at 10X.