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

• Plan for higher inflation

• Plan for lower investment returns

• Plan for clients to live longer

The current income advice framework

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

• Plan for higher inflation

• Plan for lower investment returns

• Plan for clients to live longer

The current income advice framework

8

9

Think long term and take risk..

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 ReturnEXPECTEDREAL RETURNS

Source: MacroSolutions10

Expectations for retirement income

Half Half want more than want more than

70% replacement 70% replacement incomeincome

11

Your client’s starting income

12

The current income advice framework

• Plan for higher inflation

• Plan for lower investment returns

• Plan for clients to live longer

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 PuzzlePractical Guidance for AdvisorsBy Wade PfauJuly 24, 2012

Living annuity implications

17

18

AGENDA

• The current income advice framework

• Income options for clients

• Living annuities unpacked

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?

• The current income advice framework

• Income options for clients

• Living annuities unpacked

– 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

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

* 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

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

34

SAFETY PLAN

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

37