A more conservative drawdown approach could go a long way to ensure a sustainable level of retirement income in an environment of lower expected returns.

South Africans have been spoiled by returns. In the few years leading up to the financial crisis, many fund managers were very comfortable to have a relatively high net equity exposure in their more conservative funds. This allowed retirees to benefit from returns well in excess of the risk they were taking on in their living annuities. People came to expect fantastic returns from low equity funds, feeling very comfortable that their capital was protected but also being able to draw a higher and higher income each year.

Returns for more conservative funds have probably normalised, and these investors (who chose such funds as the underlying investment in their living annuities) have had to make a decision-either draw less income, or take on more risk in order to sustain their income.

Because investors have been flattered by high returns, retirees have become accustomed to increasing their income every year-often by much more than inflation-and still seeing their investments grow. However, times have changed, and expected future returns are likely to be more muted.

As a result, retirees will generally have to be more conservative with their income going forward, and think long and hard about their equity exposure. They cannot merely invest in conservative underlying funds (where the net equity exposure is only around 20%) in a living annuity, and expect the kind of returns they got ten years ago,

The current situation

Data released by the Association for Savings and Investment South Africa (ASISA) show that living annuity policyholders withdrew on average 6.63% of their capital as income in 2013, compared with 6.7700 in 2012 and 6.99% in 2011.

Are retirees drawing too much?

This question is difficult to answer. Every individual’s circumstances will differ, and a one-size-fits-all approach when it comes to appropriate drawdowns won’t do. A more appropriate consideration would probably be how retirees could manage their drawdowns to allow the best possible chance of their money lasting.

Results show that if a retiree had a 55% equity exposure, chose an initial 4% withdrawal rate, and only increased it by inflation each year, their income would have lasted for at least 30 years in 93% of cases. Where portfolios lasted less than 30 years, it was typically due to a market correction in the first few years of retirement.

If the drawdown was increased to an initial 5%, the income would last for at least 30 years only 64% of the time. In this drawdown scenario, portfolios lasted 20 years or less in 7% of cases.

Making your retirement capital last

While drawing 4% might work for some people, it won’t work for everyone. Increasing your annual drawdown by inflation only is one of the best ways to help ensure your capital lasts as long as possible but instead of drawing the same percentage (say 4%) each year, that investors rather consider calculating a reasonable increase in absolute rand terms (taking inflation into account).

For example, if the capital amount in your retirement pot was R4 million, a drawdown of 4% would amount to R160 000 per annum. A frugal strategy would by inflation (6%) the following year (thus Rl69. 600) instead of drawing 4% on the remaining capital (which would include the growth of the fund as well).

This would not only allow the investor to draw a much more consistent level of income over time (as opposed to drawing much more in years following good investment returns and much less after poor returns), but will also allow ‘excess’ returns to compound in the fund.

Investors should also keep in mind that there may be years in the future where their investment might grow by less than inflation, while they are still drawing an inflation- adjusted return. “If you can manage by initially drawing 4% of your retirement capital without suffering a major lifestyle adjustment, increase the rand value of your withdrawals only by inflation, and maintain a suitable asset allocation over time, your money has an excellent chance of outliving you,” he concludes.