• Shaun Duddy - Actuarial analyst at Allan Gray

How to manage your living annuity in uncertain times

Presenting via Zoom webinar, Shaun Duddy discusses the “Rule Book” for managing your living annuity over the long term and interrogates whether these rules still apply in the context of COVID-19. You can watch the 44-minute presentation or see below for the key points.

Key take-outs

The primary goal of a living annuity is to provide a reasonable level of income that keeps up with inflation and lasts for the rest of the annuitant’s life. A common secondary goal is to leave a capital legacy for beneficiaries. There are four long-term rules to facilitate achieving the primary goal. These are outlined below.

The “Rule Book”

Rule 1: Plan for a reasonable number of years in retirement

While it is true that not everyone will enjoy a long retirement, there is a very real possibility that your retirement could last almost as long as your working life. According to the Actuarial Society of South Africa’s South African Annuitant Standard Mortality Tables 1996-2000, if you want to be at least 90% sure that you are planning for enough years in retirement, you need to plan for approximately 40 years at age 55, 30 at age 65, 20 at age 75 and 10 to 15 at age 85. Therefore, regardless of your age, your living annuity remains a long-term investment for a long time.

Rule 2: Invest for above inflation (i.e. real) returns

So how do you need to invest to maximise your chances of achieving the required real returns and sustaining your income over time?

Our research looking all the way back to 1900, reveals that growth assets, particularly equities, have been required to generate the necessary levels of real returns and to sustain real incomes. For example, with a 4% starting drawdown rate and needing income for 30 years, having 0% in local equities would have had approximately a 30% probability of success, while a 50% or 60% exposure to local equities would have had approximately an 80% and 90% probability of success, respectively.

Our conclusion is that as a living annuitant, you should have a minimum of 50% exposure to growth assets, such as equities, and exposures of 60% to 70% would have led to even higher probabilities of long-term success.

Rule 3: Manage volatility (but not at the expense of real returns)

Our research reveals that being able to reduce volatility without (significantly) reducing real returns, or being able to increase real returns without (significantly) increasing volatility, increases the probability of success in a living annuity. How do you achieve the right balance?

Offshore diversification can help. According to the analysis of our long-term dataset, investing 30% offshore would have allowed lower volatility while maintaining the same or higher levels of real returns, equaling or bettering the likelihood of success.

Another way to manage volatility is through quality active management. Over the 20 years from 2000 to 2019, the Allan Gray Balanced Fund has generated higher real returns than its benchmark and a passive investment of 60% equities and 40% bonds, with 30% offshore across the investment. It has also managed to generate these higher real returns at roughly equal (relative to the passive investment) and lower (relative to the benchmark) levels of volatility.

Rule 4: Draw a reasonable level of income

With 30 years