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Costly, risky allure of a living annuity

Monday, 27 August 2012   (0 Comments)
Posted by: SAIT Technical
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By Prof Matthew Lester (Tax Talk)

THE National Treasury discussion paper, "Strengthening Retirement Savings”, issued in May does not have much positive to say about living annuities.

A living annuity provides a "phased withdrawal” savings account with no longevity risk protection. Individuals must withdraw between 2.5% and 17.5% of the account each year. A wide range of investments is possible and exposure to investment risks and high costs may be substantial.

The question is, why have so many taxpayers moved over to the living annuity principal and then failed?

First is that, when presented with a retirement based on a conventional life annuity, most investors face a grim retirement prospect from day one in the Shady Pines retirement village.

Secondly, we live in a different world with interest rates of less than half those of 20 years ago. Only a Mark Shuttleworth can afford a retirement based on current bond rates.

Third comes medical costs. Just one major setback in a family is enough to severely dent most retirement plans.

Fourth is increased energy prices. Only a ponzi scheme has any prospect of yielding an after-tax return that can keep pace with today's Eskom increases.

Fifth are the Kippers (Kids In Parents' Pockets Eroding Retirement Savings). Many living annuities have been overdrawn and spent on family rather than the pensioner.

The paper does not recognise the above real-life factors that have caused many of the living annuity disasters we so often hear about today.

Living annuities underpinned with equity investments at least provide a hope of generating a high enough return, in the long term, to finance a comfortable retirement.

Yes, the living annuity is more expensive to administer. But will a cheaper alternative do the trick? I doubt it. Not without tackling the above realities.

The paper hints at the creation of a living annuity underpinned by bonds and the implementation of preservation regulations. Would it not be simpler to lower the maximum withdrawal to (say) 12% a year?

We also need to encourage investors to remain invested within the retirement fund by discouraging the withdrawal of lump sums on retirement.



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