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Local retirement savers are feeling constrained, bound as they are by the asset-spreading requirements of Regulation 28, offshore investment limits, exchange controls and perhaps even prescribed assets one of these days.
We don’t see this in other free market economies. South Africans are conditioned to living with ‘abnormal’, but these restraints are highly contentious, even more so in the current economic climate.
Compulsory annuitisation is another frustration, especially for those who plan to emigrate after retirement, because it means their capital is forever locked up in South Africa. Only the income can be expatriated, presenting unnecessary costs, paperwork and exchange rate risks.
“No one likes being told what to do – especially with their own money,” says Steven Nathan, founder and chief executive officer of 10X Investments. “It’s no surprise then that most people choose a living rather than a guaranteed annuity. It’s the lesser of the two evils, giving them at least some say over their annual income, and how their money is invested.”
Living annuities are not subject to Regulation 28 (unless part of a retirement fund’s official annuity strategy), which means there are no asset-spreading requirements and no limits on how much may be invested offshore (subject to what the asset manager allows). They would also not be subject to any prescribed asset requirements as these have been suggested for retirement funds only.
“Another big plus, which few people realise,” adds Nathan, “is that you can transfer your living annuity from one provider to another and potentially extract a lot more income from your savings.”
Section 37 of the Long-Term Insurance Act allows such transfers, provided the two insurers follow the steps set out in FSCA Directive 135.
The Directive 135 process
Directive 135 facilitates the replacement of one living annuity with another, or with a guaranteed annuity. (You cannot replace a guaranteed annuity with a living annuity. It’s a well-established principle in our retirement fund law that you can put more shackles on your money, but not less.)
Transferring is straightforward. You need to submit an application form to your prospective annuity provider, with specified supporting documents, and give formal notice at the incumbent.
In addition, the information outlined in the Annexures to Directive 135 must be shared between the parties.
Annexure 1 documents the transfer terms between the two insurers and does not involve you, the policy holder.
Annexure 2 sets out the written information you must be given, to help you make an informed decision. This includes all the important details of your current and replacement policy, and the date on which the transfer must be effected.
And, Nathan adds, in case you’re worried that the transfer will interrupt your income payments, the insurers must also explain the arrangements between them, should an annuity payment become due after you consented to the substitution, but prior to the substitution taking place.
“This ensures that you are not left out of pocket during the process,” says Nathan.
You need to sign off on these compulsory disclosures and return the signed documents to the prospective annuity provider.
In addition, you need to sign a letter (provided by the propsective insurer), giving your consent to the substitution, and confirming that you received the information required by Annexure 2 and that you are aware of the nature and terms of the substitution. Annexure 3 provides the format of this written consent.
As soon as your prospective annuity provider has received all the required signed documents, they will get the money transferred. Your investment is finalised once the money reflects in their bank account.
Managing your living annuity
“Retirement usually means saying goodbye to your pay cheque and living off your savings,” says Nathan. “This can feel a bit like losing access to piped water and having to come out with a water tank. Many people, even the well-off, struggle with this adjustment, drawing from a finite stock rather than a perpetual flow.”
But there is a way to turn your stock into a flow. That is what annuities do: they convert your savings into income.
With a guaranteed annuity, you (figuratively) hand your money to the water board and in return, they supply you with a fixed amount of water every month. “You don’t have any further say in the matter, but at least your water supply is guaranteed for the rest of your days.”
With a living annuity, you retain control over your savings. Extending the analogy, your money is channelled into a dam (invested in a portfolio), and it’s on you to manage your water consumption so you don’t run low or come up against restrictions that the law imposes.
There are four aspects you need to consider in your water management.
Your savings are steadily replenished by investment returns: interest, dividends and rising share prices. You can liken this to rain falling in your catchment area, flowing into your dam. How much depends on the ‘rainfall climate’ of your catchment area, that is on whether you are invested in a growth-orientated portfolio (holding a high percentage of shares), or a defensive portfolio (holding mainly bonds and cash). Nathan adds: “The latter will deliver more predictable returns in the short-term, but the former has historically delivered much higher returns over the long-term (five years or more).”
In the context of our analogy, inflation is like evaporating water. Your savings lose purchasing power over time because the price of goods and services keeps going up. But just as the water cycle ensures that evaporated water falls back to earth as rain, so inflationary losses are recovered in your investment returns. This doesn’t always happen immediately, but certainly over time.
“The point is,” says Nathan, “you need to recognise that part of your investment return merely compensates for inflation. You shouldn’t view this inflationary component as disposable income, but rather as your capital restoring its purchasing power.”
Because your water reservoir must last almost indefinitely you need to manage your consumption. Ideally, you would not access your capital at all and simply live off the investment returns that exceed the current inflation rate (called “real” returns).
However, not many people have enough money saved that they can afford to do that, so the living annuity model (and related calculators) assumes that you will consume some of your capital over time. The goal is to do it conservatively.
The higher the real investment return earned on your portfolio, the more you can safely draw down, without eating too much into your capital. But bear in mind that most of your inflation-beating (real) returns will come from your share market (equities) investments. Those are not guaranteed, and they are not earned in a straight line.
In deciding on your initial draw-down rate you, therefore, need to take a long-term view on the real returns you are expected to earn. Draw-downs based on how your portfolio has performed over the last year will give you a highly variable income (and no income in some years).
In the context of historical real returns earned on a high-equity portfolio, you should be safe to draw income of up to 6% pa of your portfolio, growing with inflation thereafter. Note that this 6% draw-down includes fees. On the other hand, a defensive portfolio of bonds and cash will not support even an initial 4% draw-down rate for very long.
“It’s okay to err on the side of caution; what with climate change and other uncertain factors, future real returns may be lower than in the past,” cautions Nathan.
Your capital is not depleted just by what you draw as income, but also by what your financial service providers draw as their income, by way of fees. Nathan says you can liken these fees to leaks in your dam: “You don’t see them; you just notice that the water level is falling much faster than expected.”
Unfortunately, the prudent draw-down rates mentioned above include the leakage from fees.
Government estimates the industry average annual fee for living annuity investors at approximately 2.9% of the investment balance, made up of 0.75% for advice, 0.25% for administration, 1.5% for investment management and 0.4% for VAT.
You may be drawing down conservatively at 5% pa, but if you are also paying 3% pa in fees, you are effectively drawing down at 8% pa, and cutting years off your savings.
“Fortunately, some living annuity providers, including 10X Investments, charge less than 1% pa in fees, which means you can either draw more income for yourself, or you can give yourself peace of mind that your savings will last much longer,” says Nathan.
A practical illustration of the fee impact
Assume you draw down at 5% from your R4.8m pension pot, meaning you will receive a pre-tax income of R240,000, or R20,000pm. At the industry’s average fee rate of almost 3% pa you would also be paying costs of around R144,000pa (R12,000pm). “Almost 40% of your total consumption is leaking away,” in Nathan’s words.
Moving to a low-cost provider, such as 10X Investments, which charges less than 1% pa in fees, you could instead draw R28,000 a month, and pay fees of only R4,000 pm. You are now consuming 90% yourself, “which seems a far more equitable split”.
But drawing down at 8% per annum will deplete your savings quite quickly. Depending on your choice of portfolio, you risk a drop in inflation-adjusted income within 9 to 11 years. That is the time when you are likely to hit the regulatory draw-down limit of 17,5% pa of your capital.
“Eleven years is way too early for this to happen if you retire at age 60 or 65, with a statistical life expectancy of another 15 or 20 years,” says Nathan.
The more prudent option in the above scenario, he adds, would be to keep your income unchanged, and let the 2% pa cost savings compound within your living annuity. This can add between 5 and 15 years to the sustainability of your income (again, depending on your choice of portfolio and future market returns).
Move your living annuity
While there is little you can do to increase your retirement pot once you have stopped working, there are ways to get more out of your savings, by investing for growth, sticking to an appropriate draw-down rate and keeping your fees low.
“In our experience, many living annuity holders don’t appreciate the impact of fees on the longevity of their savings,” says Nathan. “Or they don’t know they can move to a low-cost provider and give themselves an immediate income hike, or more peace of mind. Others hesitate, because the process is made to appear cumbersome, and they fear it may interfere with their income payments.”
Your incumbent financial service providers are unlikely to alert you to this opportunity, or debunk these misconceptions, “because they have much to lose by you taking your money elsewhere”, he adds.
“Your gain would be their loss. In this case, you are constrained, not by regulations but by a conflicted industry, prioritising its own interest, at the expense of your retirement.”
Fortunately, Nathan says, it is in your hands to change all that. “It doesn’t take much to free yourself from the shackles of a high cost annuity and move your money elsewhere.”
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