The tricky job of managing a living annuity through retirement

Laura du Preez | 01 July 2024

Laura du Preez has been writing about personal finance topics for more than 20 years, including eight years as personal finance editor for two leading media houses.

Investments in an investment-linked living annuity need to be managed dynamically to mitigate market risks and particularly the order in which you earn returns, Andrew Davison, chairman of the Investments Committee of the Actuarial Society of South Africa (ASSA), says.

Managing the investments from which you are drawing an income is a difficult balancing act between drawing enough income to enjoy a decent standard of living but not too much so that your capital expires before you do, Davison says.

Neither the capital, nor the income you can draw are guaranteed – you need to balance the one against the other to ensure your income lasts you for life without knowing how long you will live.

You cannot achieve this balance simply by opting to draw a low percentage of your capital (drawdown rate) and then hoping for the best, Davison says.

“A living annuity is not a set-and-forget product,” he adds. The amount you are drawing and the investment strategies may need tweaking over time, taking into account the age, gender and circumstances of the pensioner and their spouse as well as the economic environment, he says.

The investment challenge

Davison recently demonstrated that retirees using the same investment amount and strategy can have very different experiences with living annuities, depending on when they retire and what returns the market delivers.


A R1 million investment in a living annuity with the same investment strategy and drawdown rate can be depleted within 15 years or last more than 30 depending on when you retire, Andrew Davison, chairman of the Investments Committee of the Actuarial Society of South Africa, proved when testing the sustainability of living annuities using 75 hypothetical retirees.

In Davison’s research, the first pensioner retired in January 1957. Each subsequent retiree retired six months later than the previous one. 

Each pensioner invested R1 million in a multi-asset portfolio with 50 percent in equities, 30 percent in bonds and 20 percent in cash. The portfolios included offshore asset classes after this became possible in 1990 with 20 percent of the equities and 10 percent of the bonds being offshore allocations.

Costs were set at one percent.

He tested 75 hypothetical living annuities with a R1 million investment and conservative drawdown rate starting at 5.7 percent and increasing with inflation each year.

He staggered the hypothetical retirees’ retirement dates from 1957 and applied the relevant market returns to show that, depending on the order or sequence in which they earned returns, some retirees investments would have grown to more than R10 million, while the income others drew ran the R1 million down before it had had a chance to grow.

Davison found more than 12 percent of the pensioners did not have enough savings to ensure they could draw the income they needed for a 20-year lifetime in retirement.  And 42 percent did not have enough capital for a 30-year retirement.

Extreme range of outcomes

Davison says the extreme range of investment outcomes shows the need for retirees who use living annuities to regularly reassess their investments and how sustainable it is to continue drawing their current level of income.

“If the timing of your retirement places you on a less than favourable investment path, you want to recognise it and do something about it before it is too late,” Davison says.  
“The unknown of how long you might live and hence the risk of depleting your assets prematurely means that living annuities need careful management and a prudent approach to the level of income withdrawn as a monthly pension,” he adds.

Davison says a 65-year-old, single man should aim for a sustainable drawdown of around 4.5 percent with a moderate balanced investment strategy. The same pensioner 15 years later at age 80 can afford a much higher drawdown percentage of 10.5 percent with a similarly low chance of running out of money, he says.

Strategies help retirees manage

As you may potentially live a long time in retirement, you need exposure to equities to ensure your capital grows, but equity exposure introduces volatility that is difficult to manage when you are drawing a regular income.

Retirees using living annuities are often advised to use what is dubbed the bucket approach.

Under this approach, savings from which you will regularly draw an income over the shorter-term is allocated to an “income” or liquidity bucket that is invested in less volatile, lower-return investments. The balance of your savings is invested in more volatile, higher-growth investments, Andrew Cormack, INN8 Invest’s head of independent financial advisers and global distribution, told the recent Meet the Managers conference held in Cape Town and Johannesburg.

The income bucket is then topped up from the growth bucket at regular intervals.

The problem with this approach is that top ups may occur when investments in the growth bucket have been negatively affected by the markets.

INN8 Invest, a discretionary fund manager that manages investment portfolios for investors who use financial advisers, has created bucket portfolios and is actively managing the top ups from the growth to the income bucket for living annuity pensioners to minimise the risk from market returns, Cormack says.

Protecting against market falls

INN8 Invest will ensure there is always enough money in its liquidity bucket to provide living annuitants with an income for two years, he says.

Cormack says over the past 100 years the South African equity market has fallen 119 times. Ninety percent of the time, the market recovered within two years. The average period for the market to return to its previous high was in fact less than eight months, he says.

INN8 Invest believes this indicates its liquidity bucket would be sufficient to cover income drawing from living annuities without tapping into the growth bucket during times when the market is down, Cormack explains.

Smoothing returns

AlexForbes has taken a different approach to help retirees manage their living annuities by reducing the volatility of the investments.

Gyongyi King, the chief investment officer of AlexForbes Investments, told the Meet the Managers conference it has introduced a portfolio that smooths returns to mitigate the risks of drawing an income from your savings during a market downturn.

The portfolio targets investment growth using a selection of top fund managers but a portion of the returns are held in good times in order to pay better returns when markets are down, King says.

The long-term returns of the smoothed portfolio are on a par with those earned without smoothing, but back testing shows that the smoothing reduces the number of months in which there are negative returns from close to a third of a 10-year term to just three percent of the time, she says.

Back testing indicates that smoothing could keep retirees’ capital at a higher level than it would be when using the bucket approach and result in retirees being able to draw a higher minimum income, King says.

Unlike most other smoothed bonus portfolios, the returns are not guaranteed which makes the portfolio more cost effective, she says.


Set up more than one portfolio

10X Investments suggests that retirees set up more than one living annuity and invest some of their living annuities offshore.

10X consultant Brett McKay says investing in more than one living annuity allows you to use different drawdown rates and asset allocations on each annuity.

It also means you can stagger transfers to a guaranteed annuity when a more stable income is required, McKay says.

10X Investments’ solutions strategist Kelin Pottier says the right offshore weighting can also help maximise a living annuity’s longevity, but retirees must be aware of the risks that come with the volatile rand and broader range of investment returns.


About 75 percent of retirees currently choose to use investment-linked living annuities to provide a pension, according to 10X Investments. Retirees assume they will be better served by choosing their own investments and they will be able to leave any remaining capital to their heirs when they die.

If you want a guaranteed pension, you need to choose a guaranteed annuity. These annuities are currently paying relatively good rates.

These pensions can be guaranteed for your life, or for the life of both you and your spouse.