Give your clients a fair advantage when they retire

By Martiens Barnard, Marketing Actuary at Momentum Investments

Martiens Barnard, Marketing Actuary at Momentum Investments

Would your client be able to sustain their lifestyle in retirement? This seems like a straightforward yes or no question. But the answer has a complex dynamic hidden within. That is because clients who live longer in retirement will require a higher return on their investments to sustain their income.

As such, it can be difficult to make a judgement whether you are on track a few years into retirement, as you cannot simply compare the return from your investment to the return you need, as this required return varies based on how long you live.

Table 1: Years and the return required

Years of retired life152535
Return required before fees*96%11.9%11.6
*The living annuity administration fee plus financial adviser fee assumed to be equal to 1.2% inclusive of VAT. Investment management fees ignored for simplicity. The return required was set at a level such that a client would not be able to withdraw as much as they would like the next year due to the 17.5% cap on living annuity income.

The required return will of course be different for each client as it is based on personal circumstances and the income a client would need to sustain their lifestyle.

The above table is linked directly to our example of Greg, a male aged 65, who has R4 million to retire and is invested in local equities. Greg has been advised that he should draw income at a more responsible level of 5%, yet he withdraws R280 000 every year (this equates to a 7% starting income) to sustain his lifestyle. He also plans to increase this amount by 5% every year. That means Greg requires a return of at least 9.6% should he live beyond 80, and a higher return if he lives longer (see table 1).

So how would Greg have tracked historically against these required returns of 9.6%, 11.9% and 12.6%?

If we assume that Greg has already retired and we reviewed his retirement plan seven years into retirement, he would have tracked behind between 25% and 45% of the time. In table 2 we looked at the outcome after seven years had he retired at the end of any month from January 1996 to January 2015.

Table 2: Is Greg on track?

Required return before feesHistorical probability of being on track after seven years (and the historic probability of falling behind)Chances of requiring an even higher return (this is required when Greg survives for longer than the term implied by the return)
9.6%75% (25%)71%
11.9%61% (39%)33%
12.6%55% (45%)3%
Source: Momentum Investments and IRESS. 7-year rolling returns of the FTSE All-Share Index with dividends reinvested. 7-year rolling returns ending Jan 2003 to Dec 2022 (240 instances). Life expectancy assumptions are in line with the mortality assumptions as used in our life annuity pricing.

Let’s interrogate the shaded row in table 2. After the first seven years of his retirement, Greg would have been tracking behind the return he needed 39% of the time. This is based on the assumption that he needs the return to sustain his required lifestyle up to the age of 90 (see table 1). This is a life expectancy we believe about one in three men like Greg will reach.

If the history of markets (and life expectancy) is anything to go by, this means that almost four out of 10 men like Greg will track behind the return they need if we assume they will live to the age of 90. Stated differently, four out of 10 men who will live to the age of 90 has a retirement plan that is under threat as markets cannot always provide the return required to counteract the return dilemma created by longevity risk.

To try and solve this problem, what we call the living annuity risk spiral, Momentum Investments has reimagined retirement.

Greg can now, within his living annuity, enhance his investment strategy through diversification. This is because Momentum Investments can provide access to a diversified asset class that is not linked to the return from investment markets, but one that was built specifically to counteract longevity risk, ie a life annuity.

Our research has shown that by providing a living annuity where you can choose a life annuity alongside other investment components or funds (sometimes referred to as a hybrid annuity), we can significantly reduce the risk of not achieving the return needed should the client live to an advanced age.

The reason why a life annuity provides such great hedge against long-term underperformance is that it provides a better return (internal rate of return or IRR) the longer you live.

Figure 1: Internal rate of return of life annuity

Calculations based on a R1 million life annuity for a male aged 65, which pays an income of R7 161 every month escalating at 5% every year.

The values shown in figure 1 will vary on a case-to-case basis as each quote is based on various factors, including the prevailing rates at the time of purchase and the age and gender of the client; but long-term returns approaching 13.5% is not out of the ordinary.

The healthier you are, therefore, impacts not only how long you will live and the return a retiree will need, but also on the return you get from a life annuity.

By using Momentum’s Guaranteed Annuity Portfolio within a client’s living annuity, you can provide a return that increases with the client’s lifespan, thereby improving their chances of a successful retirement when they live to an advanced age.

This is how Momentum Investments is making investing personal: so that you can give your clients a fair advantage when they retire.

Momentum Wealth (Pty) Ltd (FSP 657) is an authorised financial services provider. Momentum Investments is part of Momentum Metropolitan Life Limited, an authorised financial services and registered credit provider (FSP 6406). The Retirement Income Option and the Guaranteed Annuity Portfolio are life insurance products, underwritten by Momentum Metropolitan Life Limited, a licensed life insurer under the Insurance Act and administered by Momentum Wealth (Pty) Ltd. The information in this article is for general information purposes and not intended to be an invitation to invest, professional advice or financial services under the Financial Advisory and Intermediary Services Act, 2002. Momentum Investments does not make any express or implied warranty about the accuracy of the information herein.

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