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The results of research into investment-linked living annuities (illas) versus life assurance guaranteed pensions, which were published last year in Personal Finance newspaper and then in greater detail in the current edition of Personal Finance magazine, has sparked quite a bit of debate among readers.
The research was presented by Momentum actuaries Mayur Lodhia and Johann Swanepoel at the annual convention of the Actuarial Society of South Africa late last year. Lodhia and Swanepoel concluded that most pensioners would be better off buying a guaranteed annuity – although that conclusion is based on a number of variables.
The reaction to Personal Finance’s publishing the research included one enraged Liberty financial adviser telling me that I was “borderline negligent” in publishing “an article telling consumers to take life annuities rather than living annuities”. It was apparent that the agent, who later withdrew his remarks, had not read the research, or, if he had, had failed to comprehend it.
Anyone who is about to retire should read Lodhia and Swanepoel’s research paper. Go to www.actuarialsocietyconvention.org.za, click on the “Programme” link on the homepage and then scroll down to “Papers and presentations”.
There are myriad issues you need to take into account when purchasing a pension. Your choice does not simply, as the angry Liberty agent tried to make out, boil down to current interest rate levels – in other words, that low long-term interest rates will translate into a lower guaranteed pension. The more important issue is whether or not you will outlive your capital.
Lodhia and Swanepoel based their calculations on a man who has no dependants and R1 million in retirement savings when he retires at age 65. Their model assumes a nominal interest rate (investment return) of eight percent, inflation of 5.5 percent and a real (after-inflation) return of 2.5 percent.
Importantly, the model assumes that the illa pensioner will at retirement receive exactly the same pension as he would if he had opted for a guaranteed annuity. The illa and the guaranteed pension increase in tandem to keep pace with inflation.
What happens is that the illa drawdown rate increases to such an extent that it eats into the pensioner’s capital, and eventually, once the maximum drawdown rate of 17.5 percent has been reached, the pensioner cannot draw down more to receive the same real income.
For an illa pensioner who lives for 10 years after retiring at age 65 to receive a better pension than he would have done if he had chosen a guaranteed annuity, he would have to take on almost the same level of risk as an investment portfolio that is 80-percent invested in equities and 20-percent invested in interest-earning investments, Swanepoel and Lodhia say.
Against this, a guaranteed annuity offers you a “risk-free guaranteed” return, because the life assurance company guarantees your pension.
The arguments in favour of guaranteed annuities are not unreasonable, and you should consider them.
Other research has shown that illa pensioners, unless they are suffering from a terminal illness or planning to emigrate, should not draw down more than five percent of their capital in the early years of retirement.
Figures provided by industry organisation the Association for Savings & Investment SA (Asisa) show that almost 70 percent of illa pensioners draw down more than five percent of their capital every year. And more than 21 percent of annuitants are drawing down more than 15 percent of their retirement capital.
The average drawdown rate is 9.05 percent, according to Asisa. These figures ignore costs, which can push up the draw-down rates by about two percentage points.
The main problem facing most retirees is that they have not saved enough for retirement, and no matter what annuity you choose, it will not compensate for the shortfall in capital.
Illa pensioners have been very lucky over the past 10 years, because there have been significant bull markets.
There will be a problem when investment markets stall and move sideways, or fall, for an extended period of time (see “Save more if you want to retire financially secure”, below).
Crunching the numbers to decide which pension will be better for you is not a simple task. The results will differ depending on the assumptions used – for example, altering the rate of return or the inflation rate by one percentage point up or down.
My view, at the risk of being “borderline negligent”, is that you should obtain a quotation for a guaranteed pension that will increase in line with inflation. If the amount you are quoted will provide you with more money than you require, then an illa is definitely an option, particularly if your drawdown rate will be below five percent of your capital.
If the pension you require is higher than the guaranteed annuity and an illa drawdown rate of five percent, it means you have not saved enough money for retirement. It is unlikely that an illa will solve your problem.
Financial advisers who do not at least consider a guaranteed annuity when advising their clients could find themselves the subject of complaints to financial advice ombud Noluntu Bam, who repeatedly makes it clear that she expects advisers to consider all the options.
SAVE MORE IF YOU WANT TO RETIRE FINANCIALLY SECURE
You need to be saving more for retirement to make up for changes in market conditions, according to the latest quarterly Alexander Forbes Pensions Index.
The index shows that members of defined contribution retirement funds face significantly lower projected retirement benefits compared with what they could expect at the start of 2002.
The Alexander Forbes Pensions Index tracks how projected retirement incomes have changed over time.
John Anderson, managing director: research and product development at Alexander Forbes, says the index provides values that indicate how the income that the typical person is projected to receive in retirement has changed since January 2002.
The index considers three savers, born on January 1, 1972, January 1, 1962 and January 1, 1952. On January 1, 2002, they were 30, 40 and 50 years old respectively. All three were on track to receive a pension with a replacement value equal to 75 percent of their pre-tax salaries when they retire at age 65. So, for each of the savers, their index value was 75 on January 1, 2002.
As of December 31, 2012, the index values were 52.9, 38.5 and 30.4 for the savers born in 1952, 1962 and 1972 respectively. In other words, the saver born in 1952, who is now 60 years old, was expected to receive only 52.9 percent of his final pensionable pay cheque.
Anderson says that despite good equity returns historically, it is the fall in bond yields that has driven most of the decline in the index since January 2002. The decline in yields has been brought about by developed countries, particularly the United States, forcing down the cost of money to stimulate economic growth.
Anderson says lower bond yields affect the Alexander Forbes Pensions Index in three ways:
* They can signal that investment returns will be lower, reducing the amount of capital each of the three savers is expected to have accumulated when he retires.
* They drive up the cost of guaranteed annuities. In other words, you need to invest more for every rand of pension you wish to receive.
* The overall investment return of the typical retirement fund member has generally been in line with salary inflation, which means that retirement savings have grown in line with spending power to date. However, the decline in bond yields has generally offset these gains, resulting in lower index values.
Anderson says the values indicated by the index will differ from person to person, depending on their age, gender and other factors, such as the retirement fund savings they have accumulated to date.
You should seek financial advice to evaluate whether or not you are on track for a comfortable retirement. You may find that you have to contribute more to your retirement fund and/or retire later, Anderson says.
CHARGE THOSE BEHIND CAMPAIGN TO SMEAR FSB HEAD
It’s time that National Treasury stepped in and stopped the character assassination of its officers, in particular, Dube Tshidi, chief executive of the Financial Services Board, as well as Tony Mostert, curator of various retirement funds that were stripped of their surpluses in the 1990s, to the detriment of fund members.
Tshidi and Mostert have been subjected to an ongoing campaign of vilification, particularly from the camp of industrialist Simon Nash, executive chairman of appliance company Cadac.
Nash is standing trial on charges of theft, fraud and contravening the Prevention of Organised Crime Act. The charges arise from the stripping of surpluses (more than R100 million in current values) from the Sable Industries Pension Fund and the Power Pack Pension Fund (later the Cullinan Group Pension Fund).
Contributing to the vilification campaign have been J Arthur Brown, who is standing trial for his role in the downfall of Fidentia, and a British businessman, Matthew Machin, who claims to have bought up a bundle of civil claims, amounting to billions of rands, that Brown has brought against numerous parties, including me, for “loss of earnings”.
This week, the vilification campaign and the unsupported accusations of criminal activity levelled against Tshidi and Mostert were taken to new heights.
It is unacceptable that people in public office, who need the trust of citizens, can be so violently defamed and yet the state does not take any action. Charges of criminal libel must be investigated, and those who are orchestrating the campaign must be charged.
The campaign has seen the use of anonymous websites and emails, the planting of false or incomplete information with a few naïve journalists and the production of a crude comic publication.
This week, investigative magazine Noseweek apologised for an article in its most recent edition that attacked Mostert mainly but also Tshidi and even Personal Finance. Noseweek had not verified any of the claims it made.
One of the false claims made in the article was that Mostert had recovered hundreds of millions of rands but that none of it had been distributed to former members of the retirement funds.
After Noseweek published the apology on its website, Mostert sent it out to various parties via his secretary’s email address.
Thereafter an email – ostensibly from Mostert’s secretary, but clearly a case of identity theft – was sent out to the same address list making the worst possible claims about Tshidi and Mostert.
The source of the email is not known, but it is being investigated by Mostert, who has asked the police for assistance.
Old Mutual, which is administering the surplus distribution and tracking down the beneficiaries of the reclaimed money, had, by January 31, paid out R255 million of the money recovered by Mostert.
About another R500 million is still to be paid out to former members of the affected funds.