Living annuity drawdown strategies: Which one suits your retirement lifestyle?

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A living annuity is a post-retirement investment product which provides the retiree with an income during retirement while the capital amount is invested. It is flexible, allowing you, as the investor, to select your drawdown rate, income frequency and underlying portfolio. Your drawdown rate is a crucial element of your living annuity, as it is an important factor in determining the sustainability of your investment.  

Some retirees may wish to review and adjust their drawdown rate each year, while others may be happier with a fixed drawdown rate which remains the same from year to year. In this article, we will look at different factors to help you determine which drawdown strategy would be most suited to your lifestyle, circumstances and financial plan. 

What is a drawdown strategy in retirement? 

Your drawdown strategy is the plan you use to decide how much income to take from your living annuity each year, expressed as a drawdown rate. Your drawdown rate is the percentage of the total value of your living annuity which you withdraw each year. Currently, in South Africa, you can select a drawdown rate of between 2.5% and 17.5% per annum. This can be amended before the policy’s anniversary date each year.  

You also have the freedom to select the frequency of the payments. This can be annually, biannually, quarterly or monthly, depending on your preference. The drawdown rate you select can be an essential determinant in the sustainability of your living annuity, in other words, how long your capital will last you, so this decision mustn’t be made lightly.  

Understanding fixed drawdown strategies  

A fixed drawdown rate is when you withdraw the same percentage from your living annuity each year and do not adjust this figure. For example, your drawdown rate may be set at a sustainable figure for your lifestyle, for example 4%, and this drawdown rate rolls over from one year to the next without any changes being made. There are both advantages and limitations to this strategy.  

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One positive of this strategy is that it is simple: you look at your capital, and you know what your income will be, without having to worry about running out of money. It’s easier to plan, budget and maintain a steady lifestyle. For retirees who value certainty, sticking to a fixed drawdown strategy can provide some peace of mind.  

The main downside is that a fixed rate does not take into account changing circumstances. This can be in your personal life (increased medical expenses, a change in lifestyle, etc.) or in the financial markets. In cases like these, sticking to a fixed drawdown rate might negatively impact your capital, or leave you with inadequate income for the year.   

A fixed drawdown strategy works best if, as a retiree, you are withdrawing the least possible amount from your living annuity (e.g. less than 4% ideally) and your lifestyle remains quite consistent. If your living annuity is your only source of income, caution and stability are also more important. 

Exploring dynamic drawdown strategies  

A dynamic drawdown strategy is when you review and adjust your drawdown rate each year on an ongoing basis, according to your income needs and market conditions. Instead of sticking to a fixed percentage, you take advantage of the flexibility and adapt the rate to take advantage of stronger market conditions, for example (while also hopefully ensuring your retirement savings remain sustainable over time).   

A major positive of being more dynamic with your drawdown rate is that it allows you to be responsive to change. In a year where markets perform well, you can increase your income, while in years of poor returns, you can tighten withdrawals to preserve capital. Adaptability makes this strategy the most effective for balancing short-term needs with long-term sustainability.   

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A slight drawback is that your income may fluctuate from year to year. This means that you’ll need to have greater self-discipline, as you’ll need to be more thoughtful in your budgeting and possibly reduce or delay spending when markets are down.   

Dynamic strategies are best suited to retirees who are flexible in spending habits and able to adjust budgets when needed, and those who value the long-term sustainability of their living annuity and are willing to actively manage withdrawals to achieve it. A dynamic drawdown strategy is about staying proactive and adaptable to align your living annuity with your personal circumstances. 

How to choose the right strategy for your retirement lifestyle 

When deciding on the right strategy that is best-suited to your retirement lifestyle, there are a few factors to consider and questions to ask yourself. Let’s have a look at these factors in a bit more detail:  

• What are your retirement goals? Do you plan on travelling or would you prefer a more stable, low-cost lifestyle? When you understand your long-term vision, you can see whether you need more flexibility (to accommodate variable expenses) or stability (to maintain a steady standard of living).
• What is your tolerance for risk? While some retirees are fine with adapting to the ups and downs of the market, others find fluctuating income stressful and prefer the certainty of a more fixed amount, even if it means living a more reserved lifestyle.  
• Do you have other income streams? If you have a side job, rental income or similar, your living annuity doesn’t have to hold the full weight of your expenses.  
• Do you have any health considerations that need to be taken into account? Your health will influence your financial needs. As we tend to have higher healthcare costs as we age, you may want to preserve capital in the early years. On the other hand, if you expect higher expenses while you are healthy and active, you may opt for a strategy with higher withdrawals earlier on under the expectation that expenses will decrease later.   
• Do you prefer stability or flexibility? At the end of the day, it will largely come down to whether you prefer stability or flexibility. Some retirees thrive with a set amount that does not change for the most part, while others value the freedom of being able to adjust their income each year. 

Most retirees opt for a hybrid approach, where they make use of a fixed drawdown rate and only adjust it in the occasional year where there may be extra expenses, such as an overseas trip or medical expenses. Another example of this is retirees who follow a dynamic drawdown rate, but set minimum and maximum withdrawal limits to avoid extreme fluctuations. The most important principle is to review your drawdown rate regularly and reassess whether it still aligns with your goals and lifestyle.  

The Golden Equation 

When considering your living annuity and your drawdown rate, you should also look at The Golden Equation. The Golden Equation can be written as follows: Investment Returns ≥ Inflation Rate + Fees + Drawdown Rate. 

This is a principle which can be used to manage your living annuity. This principle advises looking at your drawdown rate, fees and inflation rate versus your investment returns. For sustainability, this equation suggests that your investment returns should be equal to or greater than the sum of your drawdown rate, fees and inflation rate.  

This is a useful framework to use when planning your living annuity and drawdown rate. However, it is important to remember that returns fluctuate and can never be guaranteed. 

Living annuity fees 

As you have seen with The Golden Equation, fees can be an important factor in your living annuity. You should always be aware of the fees you are being charged on your living annuity. The typical fees which you may see charged are: 

Administration fees: These are fees charged for the administration of the fund. Administration activities include tax, reporting and compliance.  

Advisor fees: These are the fees charged by an advisor for their financial advice and services. There may be both an initial and an annual cost charged.  

Management fees: These are the fees charged for the management of the fund.  

Other fees: There may be other applicable fees, such as early exit penalties.  

Ideally, you would look to minimise fees and perhaps consider a service provider who charges lower fees. Higher fees may mean that there are fewer of your returns available to reinvest and potentially compound over the long term. Lower fees may mean that there are more returns available to be reinvested and to potentially grow over time. 

Let’s look at an example to explain the effect of high fees on your living annuity, assuming the following factors: 

• Investment amount: R2 million 
• Investment period of 25 years 
• Drawdown rate: 4% 
• Return of 12% per annum 
• An inflation rate of 6% 

Example 1 (0.86% Fees): Real investment value is approximately R2.36 million. 

Example 2 (3% Fees): Real investment value is approximately R1.45 million. 

A difference in fees of just 2% can have a major impact on the potential growth of your investment, especially when compounded over time. This example is for illustrative purposes only, and actual results may vary. You can learn more about the impact of fees here.  

The Effective Annual Cost (EAC) was established by ASISA in 2015. It refers to all fees associated with owning an investment over a one-year period. All factors being equal, a higher EAC may mean that there are fewer potential returns to reinvest. A lower EAC may mean that there are more returns available to compound over time and grow your capital. The EAC of an investment is just one factor to keep in mind when comparing service providers.  

10X provides a free EAC calculator, which is a part of a suite of free online tools offered. This calculator is a useful tool to see the fees and costs you would be charged at 10X, and this information can then be used to compare with the fees charged by your current service provider.  

10X offers a number of low-cost products with a transparent and simple fee structure, which makes it easy for all investors to understand.  We make use of an index tracking investment strategy with a more active approach to asset allocation, focusing on long-term returns for our clients. Fees at 10X are 1% or less for most retirement products, depending on the product chosen and the amount invested. For the most up-to-date fee information, please visit our website. Learn more about our investment strategy here.  

Living annuity asset allocation  

Another important part of your living annuity is the asset allocation. This refers to the mix of different assets in which your living annuity funds are invested. This is usually a mix of equities, bonds, real estate (property) and cash. As an investor with 10X, you can adjust your underlying portfolio by choosing from a selection of carefully curated funds, each with a different asset allocation and geared towards different investor types. You would look at your risk profile, aka your risk tolerance, and the time horizons when deciding on a fund.  

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If you are a more risk-tolerant investor with a longer time period, you may look to include more equities in your portfolio. Equities are the most volatile of the asset classes but may realise the highest returns in the longer term. Equities have historically produced returns above inflation by around 7% annually over the long term (based on JSE All Share Index performance versus CPI from 1960-2020); however, past performance does not guarantee future results. Bonds are more stable, but the returns may be lower. Real estate is also often a good hedge against inflation, while cash is the most stable of the assets, but most likely to generate the lowest returns. As such, if you are a more risk-averse investor with shorter timelines, you may prefer to include more bonds and cash in your portfolio.  

Diversifying across the asset classes is a good way to spread your risk. This allows you to take advantage of good returns in certain asset classes while also adding in some protection against losses in other asset classes. Further diversifying into the international market allows the investor to take advantage of the potential opportunities offshore while mitigating against any local market instability and depreciation of the Rand.  

10X offers a range of different funds within the living annuity wrapper for you to choose from. We are also able to offer a 100% offshore living annuity, which may be a good option for investors who are already invested heavily in the South African market. Find out more about the fund options on offer at 10X here.  

Final thoughts on living annuity drawdown strategies  

Choosing your drawdown strategy can take some thought and planning. It’s important to consider your individual situation and make sure that you evaluate your income needs, lifestyle, risk tolerance levels and investment timelines. You may wish to review your living annuity each year to make sure that your choices are still aligning with your goals, lifestyle and financial plan. 

If you have any queries regarding living annuities or would like to explore the 10X Living Annuity options, get in touch with the experienced and knowledgeable investment consultants at 10X.