Illustration: Bethuel Mangena
Illustration: Bethuel Mangena

Destroying units results in living annuity crisis

By Laura du Preez Time of article published Mar 11, 2017

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Many pensioners who draw an income from a living annuity are forced to reduce their pensions, particularly in the second decade of their retirement, because they have sold too many units of their underlying unit trust funds.

If their unit trusts earn healthy returns, pensioners can be misled into thinking that they can continue drawing down an income at the same or even a higher rate. But the change in the number of units held in their living annuities ultimately results in their having to cut their income, an asset manager that focuses on income investors says.

With a living annuity, you sell units in your underlying unit trust investments to provide your monthly pension or income, and to pay the investment platform fee and your financial adviser.

The dividends and interest income that your investment earns in a living annuity are reinvested, replacing some of the units you sell to provide an income.

But if your fund is not earning sufficient dividends and interest, your unit balance will steadily decrease, despite the fund earning good returns and the value of each unit increasing, Bridge Asset Management (formerly Grindrod Asset Management) says. The value of each unit increases as the prices of the underlying shares, bonds or listed property instruments held by the portfolio increase.

In recent presentations to financial advisers, Bridge shows that the unit balances of the unit trust funds typically used by living annuitants – balanced, or multi-asset, funds with a relatively high equity exposure – can decline dramatically if you are drawing an income, despite a fund producing, on average, good double-digit annual returns over 10 years.

For example, one popular unit trust fund has had solid returns of 10.6 percent a year over 10 years. One million rand invested 10 years ago on January 1, 2007 would have been worth R2.7 million on December 31 last year if you had not been drawing an income, Marc Thomas, the manager of client outcomes and product research at Bridge Asset Management, says.

However, if you are drawing an income, starting at six percent of the capital you invested in the living annuity, and increased that income by six percent a year to compensate for inflation, the situation looks very different. (Statistics from the Association for Savings & Investment South Africa (Asisa) show that the average rate at which pensioners were drawing from living annuities was 6.44 percent in 2015, despite Asisa warning that many pensioners should not draw more than five percent.)

Assume the investment of R1 million in the unit trust fund with the 10.6-percent return would have bought you one million units of a common-based unit value that enables comparisons. But, as you start drawing the income, the unit balance decreases, with just 656 000 units remaining after 10 years – a decline of more than 34 percent of the units, Thomas says. This is because the dividend and interest income that can buy more units covers, on average, just less than 30 percent of the income drawn as a pension.

A second popular unit trust fund has had a return of 11 percent a year over 10 years. One million rand invested 10 years ago would now be worth R2.8 million, but the living annuitant drawing an income would have started with one million of the indicative units and ended with 690 000 units.

The income earned by the portfolio covers only 34 percent of the income drawn, Thomas says.

He says unit trust funds that have the best returns in terms of the value of the units could still do poorly in terms of providing an income that buys back the units lost when drawing an income.

Bridge believes the solution is to have a portfolio that earns an income that matches all, or a high proportion, of the income required.

Thomas says if you are selling more units than you are buying with the dividends and interest your investments earn, you will eventually run out of money – which may be in 10, 20 or 50 years’ time. But if, over time, the units you withdraw equal the units you can buy with the income earned from your investments, you will not run out of money.

As you deplete your units, your capital value eventually declines, because your capital value is calculated by the number of units multiplied by the price of the unit. In addition, you reduce the yield or income earned on your investment, because you have fewer units on which to earn an income.

The income you earn is the number of units multiplied by the cents per unit distribution of the fund.

Bridge also recommends that the statements you, as a living annuitant, are sent include information about the units sold over the period on which the statement reports, and that you and your adviser focus on the unit balance.

Thomas says most financial advisers decide whether a living annuity pensioner should increase their income each year based on how their investments have performed relative to the previous year. If, for example, you invest R1 million and next year you have R1.1 million as a result of investment returns, your adviser will probably recommend you increase your income. But if your investment has gone down to R900 000, it is likely that your adviser will recommend your income stays level, or is cut.

The implication of this approach is that if you consult your adviser when returns for the year to date are up – say in June – he or she will recommend that your pension is increased.

On the other hand, if your review is, say, six months later when returns for the year are negative, your pension would not be increased, or you may even be advised to reduce your pension.

Bridge believes that decisions about the income you draw should be based not only on the current capital value, but also on the unit balance and the income or distributions paid per unit.

Living annuities and annual income withdrawal decisions should not be managed solely on capital values which can be highly volatile in the short term, Thomas says. Instead, unit balances and the income produced by the investments should be monitored constantly.


Here are three examples, drawn from life, that illustrate the impact of the destruction of units.

1. A living annuitant earned an average annual return of 10.87 percent on his investments between 2012 and 2016. He did not increase his income, but he lost 20 percent of the units he held in the underlying investments. The man has a life expectancy of 26 years, but, with such a large loss in his unit value, his investments may not support his income for that long.

2. The value of the units a living annuitant held in one his underlying funds increased by 34 percent over four years – the capital increased from R238 094 to R269 934 – but the investor’s unit balanced decreased by 20 percent.

3. The living annuitant earned an average return of 11 percent a year over 10 years to the end of 2016, but his unit value reduced from three million to two million units in 10 years to 2016. The man has an average life expectancy of 20 years.


• Members of pension or retirement annuity funds are obliged by law to use at least two-thirds of their retirement savings to buy an annuity (pension).

• 90 percent of people who belong to retirement funds buy living annuities and take the risk that their investments will provide an adequate income for life. The alternative is a guaranteed annuity, which guarantees a pension for life, but typically there is nothing left for your heirs.

• South African pensioners have about R350 billion invested in living annuities.

• You can draw a pension from a living annuity equal to between 2.5 and 17.5 percent of the annual value of your investment, and you can change your withdrawal rate once a year.

• Once your income reaches 17.5 percent of your investment, your income will decline in real (after-inflation) terms, because you cannot increase your withdrawal rate.

• Living annuitants face a number of risks, including: investment markets may deliver poor returns; outliving their capital; investing too conservatively; and earning bad returns in consecutive years, while not decreasing their income drawdown, with the result that their investment will be unable to recover sufficiently once markets again produce good returns.

• Some financial institutions offer a combination of a living and a guaranteed annuity that guarantees a certain level of income. With some income guaranteed, pensioners can afford to invest more aggressively with the balance of their investments in a living annuity and potentially achieve better growth.


The Financial Services Board (FSB) is concerned that pensioners may not properly understand the risks of using living annuity products, and that in many cases their money may be depleted prematurely.

The FSB, which supervises products offered to retirees and collective investment schemes, is aware that there are a number of different living annuity products available, all of which serve a very useful purpose, Jurgen Boyd, the deputy executive of investment institutions at the FSB, says.

Boyd says the presentation by Bridge Asset Management showing how unit balances in living annuities can decline despite good returns in the underlying funds, highlights the fact that proper communication with pensioners about how living annuities are affected by income withdrawals is required.

“We will take this information, together with the views of other players, into consideration when next reviewing disclosure requirements.

“Proper disclosure is required for Treating Customers Fairly purposes and to improve customer outcomes,” Boyd says.

Product providers have, in recent years, launched products that include guarantees on the number of units that provide an income, guarantees against market falls, and, most recently, a living annuity with an underlying investment in a guaranteed annuity that provides an income for life.

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