Living annuities have some awesome advantages, but also some important risks, warns Liberty’s Henk Apello. When investing in a living annuity, you must almost plan as if you are going to live forever.
Many South Africans worry about having enough money at retirement and, even if they have saved their entire working life, they may find that they still come up short of what they need.
This is a conversation Moneyweb’s Warren Thompson had with Henk Apello, who is a product developer at Liberty.
HENK APELLO: We see in the current environment people are opting to invest in something called a living annuity. Now a living annuity has some really awesome advantages, but has some really important risks that you should be aware of.
One of the advantages is being in control of the investment, so you are participating in investment growth. But there is no protection from living too long or drawing too much money out of your investments, and there is no protection from running out of money. So you have to be very careful when you decide how much you want to draw out of your investment, and that you have a strategy that will last for your whole life. People are living longer, so it’s really important to take that into consideration.
WARREN THOMPSON: Now the problem is obviously no one knows how long they are going to live. What do you suggest people do then? Has the type of investment got to change to accommodate a period for as long as perhaps 30 years post retirement?
HENK APELLO: Absolutely. When you plan your retirement in a product like a living annuity, you must almost plan as if you are going to live forever, because the reality is that as soon as you start eating into your capital the decline in your income is very quick and very severe. So within a few years you’ll be out of money or you’ll be so poor that the money that you draw isn’t enough to nearly sustain you. That’s the one thing.
The second thing is, when you are investing remember that you must invest for growth still. You need growth assets, something that can keep up with inflation, that can compensate you for your draw-down, as well as inflation every year.
Now, if we look at our client base, we see people are drawing between 6 and 8% on average. If we take out the very large investors, we see they are drawing closer to 8%. Now if you are thinking about drawing 8% out of your investment every year, with inflation at 6%, you are coming to between a 12 and 14% return that you need after taking into account fees and charges, which is very difficult to come by in the current environment.
So it’s important to know that you have flexibility, you have control, but you also have responsibility. So when the product can’t afford to pay you a certain income, you should consider or find ways to maybe try and draw a bit less for your investment to last longer.
WARREN THOMPSON: And being comfortable, holding growth assets in your retirement years, is important to doing that.
HENK APELLO: Absolutely. Again, you are not saving for a lump sum, you are not protecting a capital amount, you are protecting an income amount. So you are protecting a monthly income that you need, so investment assets that can compensate you for that. It’s a very complicated environment that we are in. If everything is growing it’s easy. So get financial help, go to a financial advisor. They’ll be able to advise you on what’s the most appropriate investment to be in.
WARREN THOMPSON: You mentioned those draw-down rates are between 6 and 8%, 8% being on the high end. How long does capital last if you draw down 8%? That to me suggests maybe 15 or 20 years max. But if you have good genes and you’ve looked after yourself, you could be going for a lot longer than that.
HENK APELLO: The 8% is actually a very high draw-down. That’s the average. So we even get people who are drawing higher than that – 10%, even 12% – and that’s not sustainable. Even at 8%, if you are not getting a 14% or a 13% return in that year, after fees and charges, then the next year maybe you’ll get the same rand amount – but if you take into account inflation, you’ll be worse off.