Ways to manage withdrawals from a living annuity

Drawing a pension from a living annuity in retirement needs to be carefully managed, or else you risk running out of money. Investment experts have come up with strategies that may serve as a guide, but they should not take precedence over the input of a trusted financial adviser.

A living annuity is a type of pension-providing investment in which your retirement savings are invested in underlying funds of your choice and you decide how much to draw from it each year, up to a maximum of 17.5 percent. Because they are market-related, returns will vary from year to year, and, in the case of a market downturn, may even be negative. Read more: How much should I draw as a pension from a living annuity?.

An annual withdrawal, or drawdown, rate of four percent initially, with the rand amount increasing by inflation each year, is generally considered to be sustainable for a retirement of between 20 and 30 years.

However, because many retirees have not saved enough, they need to draw a higher rate from their savings. A common solution is to allocate a larger proportion of the underlying investments to equities, which may provide the higher returns necessary over longer periods but are volatile over the short term.

The problem here is that drawing from your capital during a market downturn, especially if it's in the early stages of retirement, can severely affect the sustainability of your investment. Read more: What are the risks when drawing retirement income from investments?

Actuarial modelling has produced drawdown strategies that may be helpful in managing your savings under such circumstances.

Dynamic bucket system

In an essay “Dynamic income solutions for living annuities”, Andrew McCormack, head of independent financial advisers and global at discretionary fund manager INN8, describes INN8’s strategy of using two “buckets” to manage returns and drawdowns from living annuities.

The larger ”growth bucket” is invested almost entirely in equities and the smaller “liquidity bucket” is largely invested in low-risk interest-bearing investments. Income is drawn from the liquidity bucket, which is then topped up from the growth bucket.

During a market downturn, there are no top-ups from the growth bucket, allowing it to ride out the downturn. In good times, when equity returns have rebounded, the buckets are rebalanced.

Dynamic drawdown strategy

In a presentation at the 2024 Actuarial Society of South Africa conference, Kyle Hulett, co-head of investments at Sygnia, showed that by adjusting your drawdown rate depending on market conditions, you can prolong the time your savings will last.

Hulett looked at 30-year projections using different blends of equities, bonds and cash under a high-return scenario and a low-return scenario. He then looked at ways one could optimise long-term outcomes by using the following withdrawal strategies to combat market downturns:

• If your capital does not meet its expected value, do not take an inflationary increase (in other words, keep the rand amount the same).
  
  
• If your capital falls 10% below its expected value, do not take an inflationary increase and cut your income by 5%.

• If your capital falls 20% below its expected value, as it might in a recession, do not take an inflationary increase and cut your income by 10%.

Hulett found these strategies were effective for drawdowns of between five and seven percent of the capital a year, but not for higher drawdowns.

• Five percent drawdown: In the high-return scenario, the best average outcomes were from portfolios with 32 percent of assets in bonds and cash and 68 percent in equities. In the low-return scenario, the best outcomes were from portfolios with 22 percent bonds and 78 percent equities. Adopting all these strategies could lengthen your income period by up to 10 years.
  
  
• Seven percent drawdown: In the high-return scenario, the best average outcomes were from portfolios with 70 percent of assets in bonds and 30 percent in equities. In the low-return scenario, the best outcomes were from portfolios with 62 percent in bonds and 38 percent in equities. This level of drawdown was not sustainable for the 30-year period, but the strategies did improve outcomes by five to seven years.

Real-life financial planning

Devon Card, a financial adviser from Crue Invest who holds the Certified Financial Planner accreditation, says rule-based strategies can possibly serve as a guide to managing drawdowns, but they are far removed from the everyday realities that retirees face.

He says a financial planner will look at a retiree’s financial situation holistically and consider all options in finding solutions, which may or may not involve a change in investment or drawdown strategy. This will include tax implications, your appetite for risk, and a desire to leave a legacy for your heirs, he says.

Card says that, in many cases, retirees cannot go below a certain base level of income. “When retirees need to draw more than the recommended amount, then we ask how long we have sustainability at this drawdown level and whether there is room to possibly reduce it later on. Or we look at cross-generational planning, where the family can get involved and possibly provide support.

“We review a retiree’s plans regularly – often more than once a year in the early stages of retirement – and so we focus less on a portfolio's past returns than what is realistic from the portfolio moving forward, given the asset allocation.

“If the retiree is likely to face liquidity problems, then we look at the plan and the four buttons we can push:

• Reduce monthly expenditure;
• Reduce capital expenses, such as putting off buying a new car or travelling abroad;
• Revise the underlying fund strategy, taking more risk to target a better return; or
• Check what other investments are available.”

Card says if the long-term investment strategy is sound, there should be no need to make short-term changes.

“We know markets are volatile – they giveth and taketh away. So if we have a knee-jerk reaction and need to adjust the strategy every time there is a dip in the market, then we have done something wrong initially with the client and haven’t educated them enough on how markets fluctuate.”