By Kelin Pottier and Brett Mackay
In the savings and investment space, most attention is given to retirement. Rightly so too. If you’re going to maintain your standard of living for two, three, or even four decades after you stop working, you need to have as much money saved up as possible.
Unfortunately, less attention is given to ensuring your money keeps growing post-retirement. But that’s also really important. At the very least, you want your retirement savings to keep up with inflation. Even more ideally, you want them to be resilient enough to get you through major “black swan” economic events.
Investors can get the most out of existing tools, such as living and guaranteed annuities, to secure themselves that financial surety.
Living versus guaranteed annuities
When you get to retirement, there are two options facing investors, a guaranteed annuity and a living annuity.
A guaranteed annuity is an insurance-type product where you hand over the retirement savings you’ve earned over your career. The insurer then guarantees that it will pay you a fixed amount every month until you pass away.
A living annuity, on the other hand, is more of an investment style product where you get to continue investing your hard-earned savings. You also get to continue growing that money tax-free and you get to draw an income from the returns on your investments.
While there is undoubtedly greater flexibility and room for growth with a living annuity, he pointed out, it does mean investors take on all of the risk themselves. With a guaranteed annuity, on the other hand, the insurer takes on all the risk.
There is, however, a clear preference for living annuities in the wider market.
We’ve seen time and time again from our research that more than 75% of retirees actually choose to go with the living annuity because of the flexibility benefits. Another big difference is that you get to bequeath whatever capital may be left over to your beneficiaries.
Maximising longevity
With that clear preference for living annuities, how can investors maximise the longevity of this investment tool?
One option is to have more than one living annuity.
You can have more than one living annuity. It does help with flexibility. For example, you could have two different annuities with different drawdown rates and different asset allocations. You can also stagger them into guaranteed annuities as time goes on.
Another strategy is to keep drawdowns from the lump sums in your annuity (or annuities as low as possible).
Obviously, the lower the drawdown, the more sustainable the fund will be over time. As a general rule of thumb, we look at a four to five percent drawdown as a sustainable level. I think, above six percent, you start to put pressure on the funds in terms of long-term sustainability.
Maximising the tax-free portion of a living annuity, particularly within the first couple of years, can further extend its longevity.
Investors looking to maximise the longevity of their living annuities, should also carefully look at what fees they’re being charged on their living annuities. If you’re drawing down four percent and your fees are four percent, you’re effectively drawing down eight percent.
Fees are one of the biggest destroyers in terms of wealth over time. A small fee of one or two percent might not sound like a lot now but if you compound it over 20 to 30 years, it’s a massive difference in what you get out at the end of the day.
Fortunately, investors don’t have to be saddled with those kinds of fees.
Fees are something you can control as an investor. Inflation is out of our control but fees are something we can control. It’s very important to understand what your effective annual cost (EAC) is.
An EAC summarises all the fees and charges associated with your investment.
It’s great to know what your cost is and do a comparison.
Going offshore
Perhaps the most significant action any investor can take when it comes to maximising their living annuity’s longevity, however, is to ensure that it has the right offshore weighting. And here, there are some widespread misconceptions which must be addressed. In particular, people can allocate a much greater percentage of their living annuity to offshore assets than they realise.
A living annuity is not governed by Section 28 of the Pension Fund Act. So you’re not limited to allocating 45% of your assets offshore. You can invest up to 100% offshore with a living annuity, and some investors choose to do so.
The most common reasons for wanting to invest offshore are broader exposure to investment opportunities and mitigating in-country risks, particularly if they have to move at any stage.
There are also investors who are actually spending more and more time outside the country, where their income and expenses are more in hard currency rather than rands. As a result, they’re looking to match their assets and liabilities.
As to how much of their living annuities investors should hold offshore, Pottier pointed out that there is no magic number.
The answer is not zero and the answer is not necessarily a hundred percent. More often than not, the answer lies somewhere in between.
A lot, he said, depends on where the bulk of your expenses are and how much time, if any, you spend living abroad. So, for example, if the majority of your expenses are in rands, the majority of your assets should be too.
Enjoy the fluctuations
Investors must also accept a degree of risk when allocating the offshore segments of their living annuities. That’s particularly true in the South African context, where rand volatility can interact with market performance to affect your investments across a broad range of negative and positive scenarios.
That does not, however, mean that you should be volatile in your own investment choices.
Ultimately, it’s time that drives the investment risk. It’s easy to get distracted, but part of our job is to guide clients and redirect them to the long-term objective they’re trying to achieve.
* Pottier is a solutions strategist, and Mackay is a consultant at 10X investment.
PERSONAL FINANCE