The transition from a salary to a living annuity income

Moving from a regular monthly salary to an income payment from your living annuity can be a big mental shift. Retirees often don’t realise the impact of this transition, and the time it can take to adjust to this. As a retiree, you are now in charge of the amount of income that you withdraw from your living annuity. This is called your drawdown rate and managing it properly involves a fair amount of responsibility on your part, the retiree.

In this article, we will cover living annuities in more detail, including how to manage your annuity, the transition to a living annuity income and some common pitfalls to be aware of. We’ll also discuss the importance of low fees and aligning your asset allocation with your investor profile.

Living annuity income: How it works

A living annuity is a long-term investment product where the capital remains invested, and you also draw a regular income from this capital. As mentioned, you’ll have to select your drawdown rate, which is a percentage of the total value of your annuity. This rate may be amended each year at the policy anniversary date.

You can choose a drawdown rate of between 2.5% and 17.5%, depending on your income requirements and long-term retirement plan. You can also choose the frequency of your payments from monthly, quarterly, bi-annually or annually, according to your preferences. A drawdown rate of 4% or less is generally advised by financial experts to help ensure long-term sustainability.

As this is an investment product, it is subject to the different market cycles and market performance. There may be some years when the returns are good and other years when the returns are not as good. Ideally, you would look to be conservative with your drawdown rate, allowing for more returns to be reinvested and potentially grow and compound your annuity over time. As an investor with 10X, you’ll also be able to select your underlying investment funds, providing you with flexibility to cater to changing needs over time.

A living annuity is created using the retirement savings you have built up through a retirement annuity, preservation fund, or similar retirement product. When you retire, these savings are transformed into a living annuity, where they will remain invested while also providing you with an income. This can be from age 55, although many people will work a lot longer before retiring.

At 10X, we offer a low-fee and transparent living annuity with a focus on excellent returns for investors over the long term.

The emotional side of losing a payslip

It can be a transition moving from a regular, predictable monthly payslip to instead drawing an income from your retirement savings capital. There can also be some real fears associated with this, such as the fear of running out of money, the fear of a loss of financial identity or the fear associated with investment risk.

As a retiree, you are now responsible for managing your annuity to help ensure that it is sustainable. Factors such as the inflation rate, your drawdown rate, fees, and the market now need to be considered, as these can play a big role in the longevity of your living annuity. As a retiree, you may react in different ways when transitioning from a regular salary to an income payment from your annuity.

You may feel guilty spending money that has come from your living annuity, leading to underspending, or you may even feel inclined to overspend, especially if you have a substantial amount of savings built up in your annuity. Regardless of your situation, it is important to always focus on your long-term financial plan and goals and to avoid being diverted off track from these plans and goals.

The importance of asset allocation

As a retiree, you’ll also need to select your asset allocation and amend this according to your changing needs and requirements over time. Your asset allocation refers to the mix of equities, bonds, real estate and cash that your annuity is invested in. At 10X, you can choose from a selection of carefully curated investment funds, each geared towards different investor profiles and with a different mix of assets.

You may also look to invest offshore. Living annuities are not subject to Regulation 28 of the Pension Funds Act, meaning that you are able to invest it 100% offshore, should you wish. You will, of course, need to check if your service provider offers this. 10X is able to offer an annuity that can be invested 100% offshore.

When you are considering your asset allocation, you should look to align this with your investor profile, as well as your long-term financial goals. Asset allocation plays the biggest role in the performance of your living annuity, accounting for over 90% of returns, as seminal research from Brinson, Singer and Beebower shows.

You should aim to maximise returns, in order to potentially outperform inflation and cover both fees and your drawdown rate, allowing your annuity to potentially grow. Growth is important, as you want your annuity to provide for you through all of your retirement years. As such, you must have some understanding of the different types of assets.

Equities have shown to produce the best returns in the long term, but they are also the most volatile of the asset classes. As data suggests, 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) - but it is important to remember that past performance does not guarantee future results. Real estate may also produce some good returns, with bonds adding stability to a portfolio, although they are likely to produce lower returns. This is not to say that bonds will never perform, just that it’s generally seen as a more conservative option. Cash will produce the lowest returns of all the asset classes, but it is also the most liquid and stable.

Investing offshore may appeal to many investors; this may provide a hedge against local market instability and depreciation of the Rand. The international market is larger than the local South African market, providing greater access to different industries and companies, such as global tech, healthcare and more.

Your annuity allows you to switch between funds as you move through your retirement years and your investor profile changes. Your investor profile will look at your risk profile and investment timelines. Early on in retirement, for example, such as in your mid to late 50s, you may be more risk-tolerant. As you move into your mid to late 70s, you may become more risk-averse. This may look like a higher percentage of growth assets, such as equities, in your portfolio in the earlier retirement years and fewer growth assets and more bonds in your mid to late 70s, in order to match the changing risk profile and investment timelines.

At 10X, we are able to offer a wide range of funds, which provide you with access to a variety of different asset classes, both local and offshore. These funds have been strategically selected and are ready for you as an investor to select the option that ties in best with your investor profile and long-term financial plans.

Living annuity fees and why they matter more in retirement

Fees are often overlooked by investors, but the importance of low fees should never be understated. There are a number of fees that you can expect to see deducted from your annuity. These are as follows:

Administration fees: These will be administration fees deducted for admin-related tasks such as compliance, reporting and tax.

Advice fees: If you are making use of an advisor, you can expect to have an initial and an ongoing fee charged.

Management fees: These are the fees deducted for the running and management of the fund.

You should regularly review the fees that you are being charged and look to keep fees to a minimum. This is because higher fees may result in there being fewer returns to reinvest compared to lower fees, which may mean there are more returns to reinvest and potentially grow your annuity over time.

The Effective Annual Cost (EAC) refers to the total cost of owning an investment product over a one-year period of time. All factors being equal, a higher EAC would mean that less of your investment returns can be reinvested and potentially grow and compound over time, while a lower EAC may mean that more returns may be reinvested and allowed to potentially grow over the long term. The EAC of an investment should just be one element to consider when comparing different service providers.

Our EAC calculator is a useful tool as part of our free online suite of investment tools. This will allow you to compare and evaluate the EAC charged by 10X with that of other service providers. At 10X, we ensure that the fees we charge are simple and transparent. There are no hidden costs, and as an investor, you can clearly see the fees that are being deducted.

Let’s look at an example to help show the effects of fees: We will assume the following for this example:

• Investment amount: R2 million
• Investment period of 25 years
• Drawdown rate: 4% (frequency of payment: annual payment)
• 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.

What may seem like a small difference in fees can have a significant impact on your living annuity, especially when this is compounded in the long term, as we can see in this example. This example is for illustrative purposes only, and actual results may vary. Learn more about the importance of fees here. Feel free to explore our products for the most up-to-date, product-specific fee information.

Managing risk without a salary

Drawing your income from your annuity is quite different from having a regular salary as your income. A living annuity is an investment that is susceptible to market volatility and the different economic cycles. If there is a market crash, this could affect your living annuity’s value, which will then, in turn, reduce the income that you receive, as this is expressed as a percentage of the total value of your living annuity. By diversifying across the asset classes, this could help to balance your risk, as it is now spread across the different classes as the market moves through the different economic cycles.

Adding protection against market volatility in certain asset classes allows you to take advantage of any potential gains in other asset classes. For example, if there is a downturn in a certain asset class and your savings are spread across a range of different asset classes, your total portfolio will be less affected, as you have effectively spread your risk.

Common mistakes when switching to a living annuity

There are a few common mistakes that retirees may make. Let’s have a look at these:

1. A high drawdown rate: A high drawdown rate may mean that your annuity is not sustainable and that your savings run out too soon. While it may be tempting to draw more income in the early years of retirement, doing so can permanently reduce the capital available to grow and recover after market downturns.
2. A conservative asset allocation: Structuring your asset allocation too conservatively may mean less growth potential for your living annuity. Although lower-risk assets like cash and bonds feel safer, they may not generate returns that keep up with inflation over a retirement that could last well over 20 or 30 years. Without enough exposure to growth assets, your purchasing power may gradually decline.
3. Not reviewing fees: Fees should be regularly reviewed to ensure that the fees you are paying are not too high. Many retirees remain in legacy products with outdated and expensive fee structures, purely because they have failed to ever reassess them. Even small percentage differences in fees can have a major impact on how long your income lasts over time.
4. Not reviewing asset allocation: Asset allocation should be reviewed annually to ensure that it still aligns with your investor profile and long-term retirement plan. Your income needs, risk tolerance, and financial goals may change over time. As such, your investment strategy should adapt accordingly, and regular reviews can help you keep the balance between growth and stability appropriate.

Final thoughts on living annuity income

Changing from earning a regular monthly salary to a living annuity income can be a transition for you as a retiree. There needs to be a switch in mindset, which should involve careful management of your annuity with a focus on fees, drawdown rate and asset allocation. This will help to ensure that your annuity is able to provide a sustainable retirement income through your retirement years. The investment consultants at 10X are skilled, experienced and available to answer any queries regarding your living annuity and retirement plan. Don’t hesitate to get in touch and set your mind at ease on all things retirement!