Post-retirement income planning - CPDtvPost-retirement income planning Ferdi Booysen Old Mutual...

Post-retirement income planning

Ferdi Booysen

Old Mutual Wealth

June 2013

• The current income advice framework

• Income options for clients

• Living annuities unpacked

2

AGENDA

• Plan for higher inflation

• Plan for lower investment returns

• Plan for clients to live longer

The current income advice framework

3





4

Inflation eroding clients’ income

5

An SA fast food example

• 1972: A wimpy chips & colddrink

= 47c

• 2012: Same meal = R50.50

• Will investing in cash over 40

years still buy a Wimpy meal?

• Saving 47c in cash over 40

years = R23.00

6

Guaranteed annuity outcomes

7

z





8

9

Think long term and take risk..

50 years (1960 - 2010)

Shares 20.0%

Bonds 11.0%

Cash 11.0%

Weighted Average 16.5%

Inflation 8.5%

Real Return 8.0%

Realistic Returns: ± 9% - 11% p.a

If inflation averages 6% = real returns ± 3% - 5% p.a.

6.8%

6.0%

4.6%

3.5%

2.4%

AGGRESSIVE

BALANCED

DEFENSIVE

CONSERVATIVE

INCOME

SA Equities Offshore Equity Listed Property

SA Bonds Offshore Bonds SA Cash

… low RISK = low Return EXPECTED

REAL RETURNS

Source: MacroSolutions 10

Expectations for retirement income

Half want more than

70% replacement

income

11

Your client’s starting income

12





13

Longevity expectations

14

A planned retirement?

15

If we knew it would simplify income advice significantly!

• for an average 60 year old Male, life expectancy currently is

approximately 25 years

• for an average 60 year old Female, life expectancy currently is

approximately 30 years

• for an average couple age 60 years, life expectancy currently is

approximately, 35 years

Based on PA(90) mortality tables, assuming that they reflect mortality

rates in 1990 and then assuming 2.5% improvement in mortality rates

thereafter.

How long will your clients live?

16

ASSUMING that we’re using a sustainable drawdown on the living

annuity to compare.

“Individuals cannot self-insure to protect from this longevity risk, and

without annuitization they are obliged to plan for a long lifespan

… because of mortality credits and the ability of the annuity provider to

make payouts based on life expectancy rather than maximum

lifespan.”

Deciphering the Annuity Puzzle

Practical Guidance for Advisors

By Wade Pfau

July 24, 2012

Living annuity implications

17

18

AGENDA




19

Living Annuities (LA)

Strengths

• Income flexibility

• Transparency

• Investment choice

• Bequest Motive

Weakness

• Income not Guaranteed

• Investment Market Risks

• No Longevity Protection

• Behavior Gap

• Conservative portfolios

Opportunities

• Guaranteed Funds in LA

• Composite Annuities

• Hybrid Annuities

Threats

• Legislation

• Decreasing Expectations of

Real Returns on Growth Assets

• Improving Life Expectancies

Strengths

• Income Guaranteed for Life

• Investment Market Risk

• No Longevity Risk

20

Guaranteed Annuities (GA)

Weakness

• Generally no upside market

potential (except for with-profit)

• Death Benefits Limited

(Joint Life, Guaranteed Term,

CPO)

Opportunities

• With-Profit/Bonus Escalation

Option provides exposure to

upside of investment markets

with no downside risks

• Composite Annuities

Threats

• Living Annuities

– Multiple advice points

– Initial and ongoing Advice Fees

on LA but only Initial Advice

Fees on GA

• Improving Life Expectancies

• Clients who

– have reason to believe that their life expectancy will be short due to

poor health or immediate family history.

– want to be able to alter the income that they draw annually.

– are prepared to take the risk that poor market performance will

negatively impact on future income from their investment.

– Want any remaining fund benefits going to their beneficiaries on death.

– are prepared to take the risk that their retirement capital may reduce,

and therefore their income may be insufficient, especially if they draw

too much income early on.

– wish to have the ability to change the investments funds they hold.

21

Who should purchase Living Annuities?

Emotions at play

• CONTROL

– It’s my money

• POTENTIAL

– The market will perform

• RICH

– I love to look at my balance

• LIFE EXPECTANCY

– I’ll never get to 90

• TRUST

– I can manage my money

What do clients say?

22

• Clients who

– want a guaranteed income as long as they and/or their partner are alive.

– want their income to be guaranteed against any market movements.

– want to maximise the income available to them and/or their partner rather

than leave money to other beneficiaries on death.

– are prepared to sacrifice their capital in exchange for a stream of

payments, where the value they receive depends on their and/or their

partners lifespan and current bond yields

– do not wish to take risks with their retirement income.

23

Who should purchase Guaranteed Annuities?

• Composite annuity

– Combination of Living and Guaranteed Annuity in one contract

• Hybrid annuity

– Living Annuities that convert to guaranteed annuities on pre-defined

terms when Living Annuity assets run out

• Deferred annuitisation

– Living annuity is converted to a guaranteed annuity once

acceptable/improved guaranteed rates are available

24

What other options do clients have?




– What factors influence your client’s drawdown rate?

– What is an ideal LA drawdown rate?

– How can I manage LA income volatility?

– How long should I plan for the LA income to last?

25

AGENDA

• How much do you really need to live on?

– Drawing as little as you can manage initially improves the chance of

providing you with a sustainable income in future.

– Budget and see what you really need in order to live on next year.

• How much can your investment sustain?

– If the income you draw, plus ongoing charges, is greater than the growth

on your investment, your capital will diminish.

What factors influence the drawdown?

26

What is an ideal LA drawdown rate?

Source: Old Mutual Retirement Income Safety Plan

55 60 65 70 75

Male 4.00% 4.50% 5.00% 5.50% 6.00%

Female 3.50% 4.00% 4.50% 5.00% 5.50%

Couple 3.25% 3.75% 4.25% 4.75% 5.25%

27

• Growth assets are required to ensure that:

– retirement capital is not eroded, AND

– income is protected against inflation

• Low volatility is preferred to minimise the risk of drawing an

income from a depressed fund value

• Can I achieve this in a single fund?

How can I manage LA income volatility?

28

Growth assets usually mean volatility. Sequence of returns is unpredictable!

29

Growth assets usually mean volatility. Volatility impairs income sustainability!

30

Impact of volatility and sequence of returns

31

Absolute Smoothed Growth Fund

50

100

150

200

250

300

350

400

450

500

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Old Mutual Absolute Growth (Smoothing Only)**

Typical Balanced Fund*

* Source: Alexander Forbes Large Manager Watch.

** Back-tested pre April 2007

32

Historical Analysis Results (40 years to August 2011)

Smoothing Strategy outperformed on every measure

• At least as good as the most aggressive in growth and

• far better than the most conservative in protection

• “efficiency” statistics extremely compelling

Objective | Inv Strategy Aggressive Moderate Conservative Smoothed Agg

1: Long term growth 95.68% 77.74% 52.49% 100.00%

2 a): Real return >4% over rolling 5 years 80.76% 77.20% 58.67% 86.70%

b): Real return >4% over rolling 3 years 67.87% 64.94% 54.83% 79.78%

c): Real return >0% over rolling 1 year 67.16% 67.80% 68.44% 79.74%

3 a): Non-negative annual returns 87.85% 90.62% 96.16% 99.15%

b): Non-negative monthly returns 64.17% 69.79% 72.50% 99.58%

c): expected size of negative returns -8.97% -4.43% -2.33% -0.72%

Absolute Smoothed Growth Fund

33

• Full living annuity income flexibility and investment features

• Investment and drawdown experience affects timing and level of move to the Guaranteed Annuity phase

Living annuity

• “Rescue” is only triggered if living annuity income is too high relative to Safety Level

• Safe Income then kicks in for life

Guaranteed annuity

How long should I plan for the LA income to last?

34

55 60 65 70 75 80 85 90 95

Male 5.50% 6.50% 7.50% 8.50% 9.50% 10.50% 12.00% 14.50% 17.50%

Female 5.00% 6.00% 7.00% 8.00% 9.00% 10.00% 11.50% 14.00% 17.50%

Joint 4.75% 5.75% 6.75% 7.75% 8.75% 9.75% 11.25% 13.75% 17.50%

SAFETY PLAN

SAFETY

Male 4.00% 4.50% 5.00% 5.50% 6.00%

Female 3.50% 4.00% 4.50% 5.00% 5.50%

Couple 3.25% 3.75% 4.25% 4.75% 5.25%

Threshold levels –

used to reward ongoing

drawdown behaviour

Safe Income –

used to set the initial

Safe Income guaranteed

level

• Plan for higher inflation, lower investment returns and clients to live

longer!

• Living Annuities, Guaranteed Annuities, Composite Annuities and

Hybrid Annuities all have a place in the post-retirement environment

and meet different client needs.

• Client needs are often conflicting and it is not easy for one specific

solution to meet all the client’s needs and therefore trade-offs need

to be made.

• There seems to be a significant under-utilisation of Composite and

Hybrid Annuities.

Summary

36

Mickey Gambale

June 2013

Momentum Wealth

Happy living – which is

the right annuity for me?

Contents

Presentation Disclaimer

The calculations used in this presentation are for illustrative purposes only. The

information used for these calculations is based on assumptions utilised to further

the understanding of the calculations. This is not the official position or opinion of

Momentum and its employees. Momentum will accept no responsibility whatsoever

for any loss caused by negligence or otherwise, including without limitation any

direct, indirect, punitive or consequential loss resulting from the use of this

information or the calculations.

Contents

• Regulatory / industry developments: “in search of a sustainable

annuity”

• Are pensioners coping with realities?

• Guiding factors to consider

• Is any annuity going to pay you enough?

Contents

Regulatory / industry developments: “In search of a

sustainable annuity”

National treasury and retirement reform

Treasury released a number of overview discussion documents in

where they outlined the following high-level considerations:

• Costs of retirement funds and related vehicles

• The costs and risks for post-retirement income vehicles

• Preservation, portability and uniform access to retirement savings

• Savings and fiscal incentives – possible alternatives to encourage

savings

• Harmonisation of tax treatment of contributions

National treasury and retirement reform

• Reform proposals aim to extend the responsibilities of trustees to guide members through the retirement process,

• Requiring them to make a default retirement product available

• Default could be a guaranteed, living or hybrid annuity

• Option to opt out of the default with their entire retirement balance

• Trustees will be given some protection in respect of the default

• An FSB directive is expected outlining the minimum requirements that Trustees must meet.

• The final round of consultation is intended to be completed towards the middle of the year, with the first changes expected to be implemented from 2015 and forward.

ASSA Convention 2012: In search of a sustainable

retirement income

Source: Lodhia & Swanepoel 2012: Living versus Guaranteed annuities: In search of a sustainable retirement income

GAs better equipped than LAs to provide an inflation linked income for life, because:

1. Impact of mortality pooling and the drawdown cap:

Industry conclusions

Are living

annuities

appropriate

products?

• The financial adviser will assist clients in making

suitable investment decisions

• “Accused of mis-selling living annuities to reap

commissions” – from Actuarial Society Convention

• “Where was this research when we were being told to sell

living annuities by the product houses?”

Financial advisers

The Media’s

interpretation

• “Headlong plunge by 85% of retirees into living annuities at

retirement could be creating a generation of impoverished

pensioners”

• Living annuity 'not your best first choice' - Personal Finance

Retirement

Are pensioners coping with realities?

Poor decision

making

Is it possible that

some clients and

their financial

advisers do not

understand the risks

embedded in LAs?

Shady Pines

retirement village

Most presented with a

retirement based on

conventional life

annuity face a grim

retirement from day

one

Why so many taxpayers moved over to LAs and

then failed?

Changing economic

and investment

cycles

We live in a different

world with interest

rates < half those

20 years ago

Medical costs

just one major setback

in a family is enough to

severely dent most

retirement plans

Increased energy

prices

Only a Ponzi Scheme

has any prospects of

yielding an after-tax

return that can keep

pace with today’s

Eskom increases

KIPPERS

Kids in Parents’ Pockets

Eroding Retirement

Savings. Many LAs

overdrawn to support

family rather than

pensioners

Why should I trust

insurance companies

Why should I work for 40

years to give my money

away?

*Sunday Times: Money & careers by Matthew Lester

Guiding factors to consider

Is it fair to compare a life and a living annuity?

If you’re comparing life annuities to other investment products

such as a living annuities, you’re making a classic mistake!

Mistake 1: focusing on returns

• The market sells returns - people misunderstand life annuities because

financial experts and the media have focused on saving for

retirement and, to a large extent, investment returns and “return

management,” rather than risk management and, specifically, the

risk of outliving one’s assets.

• Allowing prevailing interest rates to be a deal-breaker. It’s true that

lower interest rates can mean a lower pay out, but the reason to buy an

annuity is because you want the absolute insurance of having that

income in your bank account every month for life.

Mistake 2: failing to annuitize

• Perhaps the biggest mistake is simply failing to annuitize assets to

create a guaranteed stream of retirement income.....

• A focus on historical returns may make life annuities seem like a bad

deal. But that may change going forward

• The last decade showed us that though it was fairly easy take money

from a portfolio and have that portfolio survive for a long time this

may not be the case going forward

Mistake 3: unfair comparisons - costs

• Assess the value of a annuity as though all of its costs are nothing but pure overhead is wrong

• Life annuities costs include charges for the transfer of risk. Living annuities costs are ongoing risk and portfolio management

• Any insurance product on the planet will not pay off on average. That’s something IFA’s need to recognize when we analyse risk-management strategies

• Insurance costs shouldn’t be ignored neither should investment costs. They might be too high or too low. But insurance shouldn’t be compared to investment products

Living vs.. Life annuities, should they be compared

Living annuities

• Provides for an income linked to investment portfolio

• Flexible drawdown range 2.5% - 17.5%

• The flexibility of the offering enables you to enjoy the potential

growth if the market performs

• It is an investment and not an insurance product

Living vs.. Life annuities, should they be compared

Life annuities

• Pass on all the risk to life companies

• The benefits of pooling works in

your favour, but equally so against

• You should have saved enough to

get a good starting income

• Life annuities are a insurance and

not a investment product

You have sufficient capital at retirement and

you want flexibility

You want to benefit from the mortality

benefits offered by risk pooling

You have access to skilled, trusted and

independent financial advice

You require a known guaranteed annuity

with no investment risk during retirement

You want to leave a financial inheritance when

you die

You don’t want to run the risk of out living

your income for the rest of your life

You would like to be involved in decision

making during retirement

You have a life expectancy < 15 years

Consider a Living

Annuity if

Consider Guaranteed

Annuity if

You are not married and / or you don’t care

what happens to your money when you die

You have a life expectancy > 15 years

Is any annuity going to pay you enough?

It depends on how much you’ve

saved. A life annuity isn’t a

solution for saving too little,

though it does protect you against

running out of money

Looking back on reality

Corporate John

• Current salary at retirement R500k

• Discount rate of 6%

• Investment growth of 9% pa after fees (no tax)

• Retires at age 65, wife 60

• Worked for 40 years

• Purchases joint life CPI linked annuity with 33% reduction on

first death

Looking back on reality

Corporate John example:

Pre retirement post retirement reality post retirement perfect

preservation post retirement 75% net post retirement 75%

gross

CTC / Salary 500 000 116 569 194 449 265 850 375 000

Pension 62 500 - - - -

Tax 86 000 3 152 19 582 38 225 72 420

Medical 48 000 48 000 48 000 48 000 48 000

Deductions (tax, medical, etc.) 196 500 51 152 67 582 86 225 120 420

Net 303 500 65 417 126 866 179 625 254 580

Net salary pm 25 292 5 451 10 572 14 969 18 154

Expenses 25 000 14 000 14 000 14 000 14 000

Bond 8 000 - - - -

Car 3 000 - - - -

Insurance 1 500 1 500 1 500 1 500 1 500

Travel 2 000 2 000 2 000 2 000 2 000

Food 5 000 5 000 5 000 5 000 5 000

Municipal 2 000 2 000 2 000 2 000 2 000

Clothes 1 000 1 000 1 000 1 000 1 000

Communication 500 500 500 500 500

Entertainment 2 000 2 000 2 000 2 000 2 000

Surplus / deficit 292 -8 549 -3 428 969 4 154

Total pension at retirement 2 567 116 4 278 526 5 847 384 8 245 821

% of original 60% 100% 137% 321%

Monthly % saved to achieve lump sum 12.50% 17.50% 24.00%

Pensioners look back

R -

R 1 000.00

R 2 000.00

R 3 000.00

R 4 000.00

R 5 000.00

R 6 000.00

R 7 000.00

R 8 000.00

R 9 000.00

R 10 000.00

R 11 000.00

R 12 000.00

R 13 000.00

R 14 000.00

R -

R 500 000.00

R 1000 000.00

R 1500 000.00

R 2000 000.00

R 2500 000.00

July

, 20

02

Dec

emb

er, 2

00

2

May

, 200

3

Oct

ob

er, 2

003

Mar

ch, 2

004

Au

gust

, 20

04

Jan

uar

y, 2

005

Jun

e, 2

00

5

No

vem

ber

, 200

5

Ap

ril,

20

06

Sep

tem

ber

, 20

06

Feb

ruar

y, 2

007

July

, 20

07

Dec

emb

er, 2

007

May

, 200

8

Oct

ob

er, 2

008

Mar

ch, 2

00

9

Au

gust

, 20

09

Jan

uar

y, 2

010

Jun

e, 2

01

0

No

vem

ber

, 201

0

Ap

ril,

20

11

Sep

tem

ber

, 20

11

Feb

ruar

y, 2

012

July

, 20

12

Amount - Portfolio Amount - Inflation Monthly annuity

Where to from here?

• Educate market to gain a better understanding of trade-offs between LA and GA both by client and IFA

• Retirees need to better understand the impact drawing down too much income

• Requirement for higher equity exposure and associated volatility if they opt for a living annuity

• How do we continuously support / monitor to ensure sufficient income in retirement?

• Engagement with requlators

• Collaborate across product houses and industry players to create innovative products and support one another

“Human behavior flows from three

main sources: desire, emotion,

and knowledge. ” – Plato 424-348 BC

As the people in the know our purpose should be to create

responsible solutions for stress-free living and a comfortable

retirement for all our clients

Thank you

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