Living annuities face a credibility crisis as the consequences of three years of market weakness and volatility hit home. We have sounded the early alert on a looming stress test for this popular method of assuring retirement income.
Living annuities were never the retirement income panacea for every consumer, but over the past five years, there has been substantial product take-up across a broad range of clients. Living annuities are flexible options with underlying investment in a range of assets, often biased toward equity unit trusts. Clients decide how the money is invested and the income they need. The danger is that too much will be taken too soon, depleting capital and reducing earning power.
Drawdowns like this defer the day when clients face the reality that the remaining sum is woefully inadequate. The longer the dread day is deferred, the bigger the impact and resultant financial distress. Crunch-time is imminent for some; there are already ‘cries for help’ from living annuity buyers that have endured a painful reality-check.
The gulf between pre-financial crisis assumptions and post-crisis realities is often to blame. In 2006, markets were strong and the financial service industry had become used to high returns. Post-meltdown, experts suddenly say we must all get used to low returns and high volatility. Unfortunately, many living annuity pensioners were not contacted and advised to radically adjust their strategies. A supposedly prudent drawdown level suddenly becomes an inflated and short-sighted erosion of capital if the rand value of the draw is not adjusted each year to the prudent income percentage.
Key assumptions in the living annuity market are that buyers are knowledgeable enough to work things out for themselves or will receive continued advice. When both assumptions are flawed, you have a recipe for financial distress.
Key factors include:
· A relationship breakdown between client and advisor after the advisor recommended a diversified portfolio of unit trusts – a mix requiring regular attention when markets shift;
· A slow reaction by living annuity holders who had been placed in high-risk specialist funds that lost lots of money in the downturn;
· A shock discovery by some that ‘prudent’ offshore diversification had compounded losses and impacted income potential because of the contraction of developed economies and currency movements;
· Failure to reduce draw-downs in line with new realities.
Many pensioners are not aware that up to 20% of the value of the underlying investment value is being drawn as annual income. In a low-growth environment, this means capital is quickly depleted to the point where the pension cannot fund the annuitant’s lifestyle.
Living annuities are not the best option for everyone and need to be carefully managed with the help of a qualified advisor. Perhaps some traditional pension products are better or a revised mix of options is required. Advice from qualified professionals is essential. Every delay compounds the problem.
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