Question

I am 73 and live off the income from a living annuity. Even though I have not increased my monthly income in two years, the capital value of the annuity has decreased significantly.

What can I do to ensure that I do not run out of money?

Answer

This, unfortunately, is a problem that many retired people are facing at the moment.  The flat markets of the past 5 years and the impact of Covid this year has created a situation where many pensioners are living off capital rather than interest. This is dangerous and can cause massive problems in the future. 

The good news is there are a number of things you can do – butt first some background on living annuities 

Living annuities provide a simple way for pensioners to live off their retirement income.  You invest your retirement savings  and as long as you live on less than what the investment makes, you will have an increasing pension and a nice inheritance for your heirs.

Investors in living annuities face three big risks 

• Investment risk – will their investment portfolios deliver high enough returns to cover their living expenses?
• Inflation risk – will their income keep up with inflation? 
• Longevity risk – will you eventually run out of money?

 If it is well constructed and you do not draw more than the recommended sustainable drawdown percentage, living annuities work well.  The table below gives an indication of a sustainable drawdown 

However, life happens and pensioners often need a bigger income than the recommended amount.  They may take a chance on the higher income and hope the investment returns will be good enough to sustain it.  If this does not happen or there is a market correction, they end up living off more and more of their of capital each year until they run out of money.  This is known as the pension death spiral! 

There are two ways in which I help clients get out of this pension death spiral. 

The first option is to remove as much of the investment, inflation and longevity risk as possible.  This is done as follows: 

• Work out the bare minimum that you must spend each month in order to live.
• Use some of your retirement capital to buy a life annuity to pay you a monthly pension that covers these costs.  This would be paid for the rest of your life and should increase annually

 Life annuities give pensioners a much higher pension than the recommended drawdown for a living annuity.   In the case of a 73 year old, this would be more than double. 

• At the recommended drawdown, R1 million in retirement capital would give a monthly pension of R4 200. 
• On the other hand, R1million would buy a life annuity of around R9 400 per month, increasing by 5% each year. 

 Many people resist buying life annuities as they want to leave an inheritance.  If leaving an inheritance is important, there are structures available where you can get a life annuity that also pay out a capital amount equal to your original investment should you die.  

The life annuity has helped you cover your basic living costs for the rest of your life.  Inflation has also been controlled to come extent with the increasing annuity.  This higher income will have reduced the size of drawdown needed.  

If the living annuity drawdown is still too high to be sustainable level then you need to earn more from the investment portfolios.  The challenge is to get a higher level of growth out of the portfolio without exposing the client to too much risk.  These are pensioners and they cannot afford to take risks.  

A well-constructed portfolio can provide both growth and income without exposing the client to too much risk.   There are also special living annuity portfolios available which use of financial structures like hedging and smoothing to provide high levels of growth at a low level of risk.  Your financial adviser would be able to help you here. 

Using a life annuity and paying close attention to your investment portfolios can go a long way towards solving your problem and prevent you from entering the pension death spiral.