Living annuity planning: Preparing for healthcare costs in retirement

• Healthcare costs can become a major part of retirement planning, so living annuity investors need to factor these in when reviewing retirement income.
• Drawdown rate, fees, inflation and fund selection all affect the long-term sustainability of an annuity, especially if rising healthcare costs place extra pressure on the income being withdrawn.
• Reviewing healthcare costs before your policy anniversary date can help you decide whether your drawdown rate, emergency savings, beneficiary nominations and overall plan still suit your needs.

Your living annuity may need to cover more than just your everyday living expenses in retirement, as healthcare costs are an important consideration. This may include medication, assisted living, specialist appointments, and other related expenses. The need for greater medical care and the resulting expenses may become more significant as you get older. It is important that this aspect of the retirement years is factored into your annuity management and retirement planning. In this article, we will take a closer look at the importance of keeping healthcare costs in mind, and how this should impact decisions surrounding drawdown rates, fees, fund selection, emergency savings, inflation, annual reviews, and more. We’ll also look at how 10X is able to support you as a 10X investor.

Understanding living annuities

A living annuity is a retirement product that allows you to withdraw income while the remaining capital remains invested in the market. This kind of annuity comes with a high level of flexibility, allowing you to choose both your income withdrawal rate, known as your drawdown rate, and the funds in which your capital is invested. Your annuity is funded by your retirement savings, transferred into the annuity when you retire. You may amend your drawdown rate annually on the policy anniversary date. The rate must be between 2.5% and 17.5% per annum. You may also change your fund selection if your current choice no longer meets your needs or long-term financial plan.

Why healthcare costs matter

Healthcare costs can be unpredictable. Some retirees may find that they don’t have many medical expenses and that these costs remain fairly stable, whereas others may incur medical costs related to illness, the need for assisted care or chronic conditions. This can mean careful planning for your annuity, as it will need to support your income needs throughout your retirement years. Medical expenses can also change at different stages of retirement. Costs that feel manageable early on may increase later due to higher medical aid premiums, medication, specialist care, mobility support or the need for additional day-to-day assistance. This is why healthcare should be treated as an ongoing planning factor, rather than a once-off expense. If you do see a rise in medical costs, it may be tempting to increase your drawdown rate, which can then affect your invested capital. This is because there may now be less capital available to compound and grow over time.

A higher drawdown may help cover immediate healthcare needs, but it can also place pressure on the long-term sustainability of your annuity. Before making changes, it is worth considering whether the increase is temporary or likely to continue, and whether your broader retirement plan can support a higher income withdrawal over time.

Understand your current healthcare spending

A good place to start is by reviewing your current healthcare spending to get an overall picture of your finances and see how much of your monthly income goes toward medical expenses. Include medication, specialist appointments, dental and eye care, medical aid premiums, gap cover, and any other related costs. You may also want to compare your current expenses with those from the past year to see whether anything has changed.

This review can help you separate regular monthly costs from once-off or occasional expenses. For example, medical aid contributions and chronic medication may be predictable, while specialist appointments, procedures, dental work or new prescriptions may be less consistent. Understanding both types of costs can give you a clearer view of the income your annuity may need to support.

Plan for healthcare inflation, not just general inflation

Inflation can be an important risk factor for your retirement years. It erodes the purchasing power of your capital. This means the range of goods and services you can afford shrinks, and your money does not go as far as it did before. The annual inflation rate in South Africa has recently been around the mid-4% range

While general inflation affects everyday expenses, healthcare costs may create additional pressure in retirement. Medical aid premiums, medication, specialist consultations, gap cover and out-of-pocket treatment costs can all increase over time. This means that your annuity may need to support both ordinary living costs and medical expenses that become more significant as you get older.

A useful planning guide to consider when you are planning is the following ‘golden equation’: Drawdown rate + fees + inflation ≤ investment returns.

You would aim for your investment returns to be able to cover your drawdown rate, the fees that you are paying, as well as the inflation rate. The golden equation is not a guarantee but rather a useful way to think about your annuity and its sustainability.

When healthcare costs are included in your planning, this equation becomes even more relevant. If your medical expenses rise faster than expected, you may feel pressure to increase your drawdown rate. This can reduce the capital that remains invested and may affect the long-term sustainability of your annuity. Reviewing healthcare costs each year can therefore help you make informed decisions about income, fees, fund selection and your broader retirement plan.

How healthcare costs can affect your drawdown rate

As previously mentioned, you can choose a drawdown rate of between 2.5% and 17.5% per year. When choosing your rate, you’ll also need to consider whether your living annuity will remain sustainable over time, so that you don’t outlive your capital. Many industry professionals consider a 4% drawdown rate sustainable, as research from William Bengen indicated, but this isn’t guaranteed, however, and should be treated only as a planning guideline.

Healthcare costs may affect your choice, and you may need a higher drawdown rate to cover them. Keep in mind, however, that a higher rate leaves less capital invested in the market to potentially grow and compound, which may affect the sustainability of your annuity.

Why asset allocation matters when healthcare costs rise

As an investor, you are able to select the underlying funds that your capital is invested in. Research by Brinson, Singer, and Beebower shows that your asset allocation can be an important determinant of the growth of your annuity. At 10X, you are able to select from a range of different funds that include a mix of the different asset classes, meaning you will not need to select the specific bonds, property or shares yourself.

Each fund has a predetermined combination of asset classes and is designed for a specific type of investor, risk profile and investment horizon. You would look to ensure that your fund selection is well aligned with your investment timelines, risk profile, and long-term financial plan and goals. Living annuities are not subject to Regulation 28 of the Pension Funds Act, which means you will not be restricted when it comes to investing in equities and offshore.

You may like to include equities in your portfolio to provide long-term capital growth as well as returns that may potentially beat inflation. Equities may experience significant market declines, but they also provide you with exposure to both companies and economic growth. Value may fluctuate considerably over shorter periods. They may be best suited to investors with longer time horizons and the ability to tolerate greater portfolio volatility. Equities have historically delivered returns above inflation by approximately 7% annually over long periods (based on JSE All Share Index performance versus CPI from 1960-2020).

Real estate helps generate income through rentals and distributions. It may contribute to long-term portfolio growth. Listed property may be volatile and impacted by factors such as interest rates, economic conditions, occupancy levels and any changes in the property market. Real estate may serve as a good hedge against inflation.

Bonds can provide stability, income and diversification in your portfolio. They won’t be completely risk-free, but they are generally less volatile than equities and real estate. They are often considered one of the more conservative asset classes, but they can outperform expectations. Bond values can be affected by interest rate changes, inflation expectations, and the issuer's ability to repay its debt.

Cash is considered the most liquid and stable of the asset classes. It is less likely to experience the same levels of volatility as the growth assets, such as equities or real estate. It may be the case that cash struggles to keep pace with inflation over long periods. This may then affect purchasing power.

Our funds at 10X offer exposure to all of the asset classes, including both local and offshore exposure. Please visit our fund page to find out more about the various funds that we have on offer.

The role of emergency savings

It may also be wise to keep some savings readily accessible for emergency medical treatment or other short-term costs. Ideally, you wouldn’t rely solely on your living annuity to cover medical expenses, which can be unexpected.

Knowing you have accessible savings when you need them can provide peace of mind and help you avoid making rushed decisions about your drawdown rate. Increasing that rate to cover medical expenses may put further pressure on your annuity capital over time.

Fees matter when healthcare costs are increasing

High fees may reduce the returns available to reinvest in your living annuity, which may in turn affect the growth of your capital over the long term. This may be further compounded if you are also experiencing rising medical costs and need your annuity to support them.

Some of the common fees that you may be charged are the following:

• Administration fees: The fees which are charged for the admin tasks related to the fund. This would include compliance, tax and reporting, amongst others.
• Advisor fees: There will usually be an initial and an ongoing fee charged for the advice and services that a financial advisor offers.
• Management fees: Fees which are charged for the running of the fund.

Here is an example showing the effect of fees when compounded over time. We will assume the following information in our example:

• Starting capital: R4 million
• Investment period: 25 years
• Gross annual return: 10%
• Annual inflation: 5%
• Annual drawdown rate: 4% of the opening value each year

Scenario 1 - 0.86% Fees: After 25 years, the annuity would have an estimated inflation-adjusted value of around R4.3 million. Scenario 2 - 3% Fees: After 25 years, the annuity would have an estimated inflation-adjusted value of around R2.5 million.

A small difference in fees can lead to much larger differences in retirement outcomes. This example is for illustrative purposes only and real results may vary. You can read more about the effects of fees in this maths article. The following terms are important to understand as an investor when analysing fees:

• Total Expense Ratio (TER): These are the ongoing expenses within an investment fund. (A way to compare the operating costs of similar funds, but it is not the final cost)
• Total Investment Charge (TIC): This 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.

Effective Annual Cost helps you to understand the full cost of holding an investment over time. Introduced by ASISA in 2015, the EAC combines various charges linked to an investment into a single annual percentage, which can usually be found on your investment statement. Depending on the product, this may include investment management fees, administration costs, advice fees, penalties, guarantees and more.

Assuming all other factors are equal, a lower EAC may usually mean that a larger portion of your money remains invested and available to potentially earn returns. A higher EAC may mean fewer returns to reinvest and potentially grow over time. Costs should be just one factor to consider when comparing service providers. Our fees at 10X are simple, transparent and cost-effective. Please view our living annuity page to find out more about the fees charged.

Review healthcare costs before your policy anniversary date

Your policy anniversary date can be a good opportunity to review your annuity and your healthcare costs. This is the date at which your annuity was implemented. A review will provide you with a holistic view of where you stand with your annuity. You would want to review your drawdown rate, income needs, fund selection, fees, beneficiary nomination and your healthcare costs. It can also be helpful to compare your existing medical expenses to those of the previous year. If your medical aid premiums, gap cover, medication or specialist costs have increased, this may affect the level of income you need from your annuity.

Let’s look at a few questions you may like to consider during your review process:

1. Is your drawdown rate sustainable?
2. Does your fund selection match your needs, investor profile and long-term financial plan?
3. Do you have accessible emergency savings for healthcare costs, if needed?
4. Have your medical aid or gap cover premiums increased?
5. Has your health changed during the year?
6. Are you expecting any upcoming health expenses?
7. Has your income need changed because of medical costs?
8. Would increasing your drawdown rate place pressure on your remaining capital?
9. Are your beneficiary nominations still up to date?
10. Do your fees remain appropriate for your annuity and long-term plan?

How 10X can support investors

At 10X, we like to support our investors by offering a range of free online tools for you to access easily on our website. Our online tools for retirement planning are the EAC Calculator and the Living Annuity Calculator. You will also have access to our experienced and efficient 10X investment consultants, who are just a phone call away. Check out our other calculators too.

We use an index-based investment strategy that includes a more active approach to asset allocation. You can expect low-cost, transparent fees that are simple and easy for investors to understand. We also have a wide range of funds that have been carefully selected in order to provide you with access to a variety of different asset classes, including both local and offshore assets.

Final thoughts on living annuity planning

Healthcare costs can affect your retirement savings, so it’s important to factor them into your retirement planning. During your annual review, make sure you revisit these costs alongside your drawdown rate, income needs, fees, fund selection, beneficiary nominations, inflation and long-term sustainability. If you haven’t reviewed your healthcare expenses recently, now is a good time to do so. And if you’re finding any part of your retirement planning challenging, the knowledgeable and helpful 10X investment consultants are available to answer any queries you may have. Get in touch today to learn more or get started on a 10X Living Annuity.