Why some retirees struggle with living annuities (and how to make them work for you)

The switch to a living annuity can be hard for many retirees and does involve a mindset shift. Transitioning from a regular, predictable monthly paycheque to drawing income from your accumulated retirement capital can feel daunting and emotional. It can also bring fear and uncertainty.

In this article, we’ll take a closer look at the transition to a living annuity by focusing on the key factors that influence it. We will cover areas such as fees, asset allocation, drawdown rate and more.

Recap of living annuities

Your living annuity is funded upon retirement by the capital that you have saved in your retirement annuity, preservation fund, pension or provident fund. This can be from the age of 55 in South Africa. Once you retire, your savings are transferred into a living annuity, where the capital remains invested while also providing you with an income during retirement.

The income you receive from your annuity is determined by your selected drawdown rate. This can be amended each year at the policy anniversary date, allowing you to cater for changing income requirements or financial circumstances. Choosing a lower drawdown rate, if possible, may help ensure the longevity of your annuity. Generally, financial experts believe 4% to be a sustainable drawdown rate.

You can receive your income annually, biannually, quarterly or monthly, depending on what works best for you. Another key feature of living annuities is investment flexibility. You can choose the underlying investment funds that your capital is invested in and adjust this over time to keep them aligned with your risk profile, retirement goals and changing financial needs.

Another major appeal is the ability to pass on the remaining capital of your living annuity to your beneficiaries outside of your estate, which means it will be tax-free.

The shift no one prepares you for: From saving to spending

The shift in mindset from saving to spending can come as a surprise when retirement arrives. Decision-making may feel high-stakes, and you may also find yourself spending a lot of time ‘watching’ the markets to gauge their potential impact on your living annuity. You may also experience fears, such as longevity risk or losing money.

These are all real and understandable concerns. Instead of building up your savings, you are now drawing on them and using this capital as income. As your living annuity is invested in the market, it is subject to market volatility, which can be anxiety-inducing. There are also a number of vital decisions to be made regarding your annuity. For example, you would need to carefully consider your drawdown rate and your asset allocation, and review fees to ensure that they are not excessive.

Too much choice: The hidden cost of flexibility

Flexibility can be a great thing, but it can also bring decision fatigue and anxiety. You may spend a lot of time overthinking things like your drawdown rate and asset allocation. Over time, this can lead to decision fatigue and uncertainty, especially in periods of market volatility.

For example, some retirees may become overly conservative in their asset allocation because they are worried about market declines and losing capital. While this may feel safer in the short term, being overly invested in cash or low-growth assets can reduce the long-term growth potential of the portfolio and increase the risk of your annuity not keeping pace with inflation. Maintaining exposure to growth assets such as equities is important, even during retirement.

More flexibility also creates the temptation to react to short-term market movements by switching funds or changing strategies too often. These emotional decisions may move investors away from their original long-term retirement and financial goals. The ideal retirement experience is one that offers stability, predictability and peace of mind. This is why it’s important to approach the flexibility of a living annuity with discipline, structure and a clear long-term investment strategy.

Asset allocation anxiety: Getting risk “wrong” feels catastrophic

You may feel pressure to get your asset allocation right, while getting it ‘wrong’ can feel disastrous. In fact, 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.

Your asset allocation will usually consist of a variety of different asset classes. These are equities, bonds, real estate (property) and cash. You will need to carefully consider your risk profile, time horizons and financial plan and goals. Your risk profile refers to how risk-averse or risk-tolerant you are when it comes to market volatility and potential short-term market losses. Your time horizon refers to how long you anticipate needing your living annuity.

At 10X, you have the freedom to adjust your portfolio by choosing from a range of carefully curated investment funds, each with a different mix of assets and geared towards different investor profiles.

Equities are generally thought to be the most volatile of the asset classes, while also generating the best returns in the long term. 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 past performance doesn’t guarantee future results.

As you are not adding any further contributions to your annuity, you want to ensure that you include equities in your portfolio in order to target growth and ideally outperform inflation. Bonds may produce some lower returns, but they will also add some stability to your portfolio. This doesn’t mean bonds will never outperform expectations, just that they are typically seen as a more conservative option. Real estate can be a good hedge against inflation and produce solid returns. Cash is very stable but will likely produce the lowest returns of all the asset classes.

You may also consider investing offshore; you are able to invest your living annuity 100% offshore, as long as this is offered by your service provider. Investing offshore allows for further diversification and may provide a good hedge against any local market instability and depreciation of the Rand.

At 10X, we offer a variety of well-diversified funds that give investors access to both local and offshore assets and different asset classes, allowing you to align your fund selection with your investor profile and long-term financial goals. Please explore our funds for the most up-to-date fund information.

Why living annuity fees feel small but matter more in retirement

Even just a small difference in fees can have an impact on the potential growth of your living annuity. This is especially true when fees are compounded over the long term, for example, 25 to 30 years. High fees can reduce the returns available for reinvestment and therefore for growth over time. As fees are something that you have some control over, it’s important that these are carefully watched and that steps are taken to minimise fees if they are found to be high. Let’s look at an example which will help to show the effect that fees can have. We will assume the following information for this example:

• Investment amount: R2 million
• Investment period of 25 years
• Drawdown rate: 4% (assuming an 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.

As this example shows, a small difference in fees can have a significant impact on your real investment value, especially when compounded over time. This example is for illustrative purposes only, and actual results may vary. You can learn more about fees here. There are some fees that you can expect to see deducted. These are the following fees:

• Management fees: These are the fees charged for the running and management of the fund.
• Advisor fees: Your advisor will offer you advice and other services. They may charge both an initial and an ongoing fee for these.
• Administration fees: These will be admin-related tasks, such as compliance, tax, and similar, so an administration fee will be incurred.

The Effective Annual Cost (EAC) is an important metric that ASISA introduced in 2015. This metric allows you to see the costs that are involved with owning an investment 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 of your returns may be reinvested and potentially grow over the long term.

The EAC is usually shown as a percentage, and it can be found on your statement or requested from your service provider. The EAC of an investment is just one factor to consider when comparing service providers. This EAC calculator is a handy tool which you can use to compare and evaluate your EAC. It is a part of the free online suite of resources offered by 10X. At 10X, we keep fees low and transparent, so you can be sure that there are no hidden fees. Fees on retirement products are usually 1% or less. Please explore our products for product-specific fee information.

Making the decision easier: Principles that reduce regret

When it comes to planning your living annuity, you would generally want to focus on three key areas:

• A sustainable drawdown rate: A sustainable drawdown rate is imperative. Your selected drawdown rate should be 4% or less if this is possible, as financial experts believe this to be sustainable.
• Longevity planning: Your living annuity is a long-term investment, so you want to ensure that it will provide for you throughout your retirement years. You may look at 25 to 30 years.
• Asset allocation for growth: Your asset allocation should be aligned with your investor profile. Generally, you would want to include some equities in an investment fund.
• Use structure to protect against emotion. You should always focus on the long game and your long-term financial plan and goals. Your asset allocation should be carefully structured to align with your long-term financial plan and investor profile. You should avoid making unnecessary changes to your asset allocation and steer clear of emotional reactions or knee-jerk decision-making in response to short-term market noise.
• Control what you can. In areas where you have more control, such as fees, you would look to leverage them. Ensuring a well-diversified portfolio will help you balance risk and reward. A disciplined and consistent approach to your investing and retirement habits may be a key factor in the success of your living annuity.

How a rules-based investment strategy can help

At 10X, we use an index-tracking investment strategy with a more active approach to asset allocation, while aiming for superior long-term returns for our clients. We are also cost-effective and transparent about the fees we charge.

Our strategy aligns well with addressing the struggles that many retirees may face during their retirement years. We offer access to a range of well-diversified funds with transparency and simplicity, helping make investing and retiring less emotional and easier for all to understand.

The 10X Living Annuity is a great choice for these reasons.

You can also speak to our expert investment consultants who are here to help you with any queries or questions that you may have regarding your retirement.

Conclusion: Confidence comes from clarity, not control

Transitioning to a living annuity can be a difficult shift for a retiree, and it can take some time to get used to this new normal. Living annuities can be complex to manage, and there are a few factors that you, as the retiree, will need to consider.

Keeping things simple while focusing on discipline, low fees, a strategic asset allocation and an annual review will help ensure that your living annuity stays on track. Try to avoid overthinking and unnecessary tweaks when it comes to your living annuity, and rather focus on the long-term and aligning with your financial plan and goals.

As always, our experienced and helpful investment consultants are at your service to help you transition to retirement. Don’t hesitate to call us if you have any queries!