Living annuity drawdown rate is personal

South African retirees drawing a pension from an investment-linked living annuity are drawing on average 6.6% of their capital a year, according to statistics released recently by the Association for Savings and Investment South Africa (ASISA).

But retirees shouldn’t use this 2022 average to guide them on how much to draw as a pension – it could be too high or too low for you depending on your circumstances.

Retirement fund savings that must be used to buy a pension at retirement can be used in one of two ways. You can either invest in a living annuity and draw an income from your investments, or you can buy a guaranteed life annuity. Read more: What kinds of annuities (pension) can I buy when I retire?

A guaranteed life annuity ensures you will receive a certain income for the rest of your life. The income you draw from a living annuity, however, must be managed to ensure it lasts and you must draw between 2.5% and 17.5% of the capital invested each year. You can change the drawdown rate once a year.

Most retirees choose a starting level or drawdown rate and increase their income by inflation each year.

There are some broad guidelines on the level of income to draw that will ensure your living annuity savings will continue to provide an income that keeps up with inflation throughout your retirement. But these guidelines do not take your unique situation into account.

Jaco van Tonder, deputy chair of the ASISA marketing and distribution board committee, says rates of 4% to 5% in the first decade of retirement and below 8% in the later retirement years are generally considered prudent and capable of providing a pension that keeps up with inflation over your lifetime.

Significant risk

The statistics show many retirees are drawing incomes in line with these guidelines. But there are some annuitants drawing much higher levels of income – for example, among retirees aged 55 to 69 years, 30% (by value invested) are drawing more than 7.5% of the value of their savings, the statistics show.

Van Tonder says any retiree under the age of 80 drawing more than 8% as an income from a living annuity “runs a significant risk of running out” of capital to sustain the income they need.

But to determine whether the level you are drawing is safe for you personally depends on three things:

• How much savings you have in the living annuity and in other annuities or investments;
  
  
• How well your investment performs; and
  
  
• How long you are likely to live.

Read more: How much should I draw as a pension from a living annuity?

Pieter Hugo, the chief client and distribution officer at M&G Investments, says most people have multiple living annuities as well as other discretionary investments, all of which fund their retirement income. 

There may be reasons why you would draw a high percentage from one of your living annuities - for example, to deplete a smaller living annuity with relatively high administration costs, he says.

Insufficient savings

But there are many South African retirees who are drawing dangerously high levels from living annuities as a result of the rolling on of the problem of retiring with insufficient savings, Van Tonder says.

He says a significant proportion – 30% to 40% of South African retirement fund members - reach retirement with insufficient savings for a comfortable income in retirement.

The high cost of living and failure of markets in recent years to deliver good returns have also contributed to retirees being forced to increase their drawdown rates, he says.

Increasing an already high drawdown rate by inflation each year can quickly take you to the maximum 17.5% you can draw.  When you reach this level – often referred to as the point of ruin – you will be unable to increase the amount you draw and inflation will quickly erode the value of your income. Read more: What are the risks when drawing retirement income from investments?)

Difficult choices

Van Tonder says if you retire with insufficient savings, there is no silver bullet that can rescue your retirement plan.

Your choices are:

• To absorb the impact of insufficient retirement savings from day one and invest in a guaranteed life annuity that will increase each year. With this option, unless you choose an annual increase linked to inflation, you take the risk that the increase may not match inflation.

• Delay the impact of the insufficient retirement savings by investing in a living annuity designed to produce a high income, but run the very real risk of running out of money in your later retirement years.

Hugo says if your life expectancy is more than 20 years, you need to draw a percentage that is less than your expected real (after inflation) return on your living annuity investments. Your expected return is in turn based on the assets (equities, bonds, cash or listed property) in the investment portfolio you chose.

Drawing more than the return will quickly erode your capital, and if it is likely to run out within your expected lifespan, Van Tonder says you should consider:

• If you are still fairly young, continuing with some type of part-time work to take the pressure off your annuity income;
  
  
• Liquidating other assets, such as a large family house in favour of a smaller, cheaper home;
  
  
• Switching part of your living annuity to a guaranteed life annuity so that a certain minimum income is guaranteed for life.

Check your rate every year

If you have a living annuity, the best thing you or your financial adviser can do on every anniversary of your living annuity policy is to check the level you are drawing against living annuity guidelines issued by ASISA, Van Tonder says.

These guidelines show how long you will continue to draw an income at a particular level given the return you are earning on your savings.

The guidelines illustrate that when you are drawing an income above 7.5% of your capital, it generally leaves you with less than 10 years of income before you will reach the maximum you can draw.

LIVING ANNUITY GUIDELINES
Annual income rate selected at inception	Investment return per annum (before inflation and after all fees)
	2.5%	5%	7.5%	10%	12.5%
	Years before your income will start to reduce
2.50%	21	30	50+	50+	50+
5.00%	11	14	19	33	50+
7.50%	6	8	10	13	22
10.00%	5	5	6	7	9
12.50%	2	3	3	4	5
15.00%	1	1	2	2	2
17.50%	1	1	1	1	1
Source: Association of Savings and Investments South Africa

The Financial Sector Conduct Authority has also published a draft conduct standard for retirement funds that offer living annuities as their default annuities for retiring members.

This standard proposes recommended drawdown levels based on age. These recommended rates suggest a 5% drawdown rate for those aged 65 at retirement and up to 7% for those aged 85 or older.

Follow advice

Most retirees drawing a pension from a living annuity are getting financial advice and advisers are very tuned to the fact that those who draw high rates risk depleting their capital, Van Tonder says. Read more: How can I find a good financial adviser?

When retirees draw more than a financial adviser recommends, advisers typically ask them to sign a record of advice stating that they understand the risk, he says.