By Richard Carter
By Robert Laura
Most retirees opt for the investment-linked life annuity (ILLA), or commonly known as a living annuity, when they retire from their retirement funds because it offers flexibility of income and investment choice. Moreover, it has the option of bequeathing residual capital to beneficiaries, which is not possible with conventional guaranteed life annuities. Living annuities, however, do not come without risks – one major risk is that because of a lengthy period of poor market returns, the capital value of a living annuity will be reduced to such an extent that it won’t be possible to sustain the expected income levels going forward.
What possible pro-active measures can a retiree implement to prevent such a catastrophic event? First, it is about starting off with a realistic withdrawal (drawdown) rate, not drawing down more than 6% of the fund value, but preferably 5% and less if one is planning for a post-retirement period of up to 30 years. Second, investment (fund) selection – it’s best to consult experts with the selection and balancing process. Third, the flexibility to change one’s income withdrawals (retirement spending) from year to year, and re-aligning it with situations where portfolio returns may turn out negative, hence leading to declines in fund values (besides regularly drawing down retirement income from the portfolio).
The first two actions refer to the planning and setting up of the retirement plan, while the last measure is a tactical ploy really while already in retirement, and adjusting the drawdown to safeguard against a drastic shortening of the longevity of the retirement plan.
This discussion focuses on the latter option – what possible remedial actions can be taken to protect the future long-term viability of the retirement plan, more specifically, at the annual “income review” (every 12 months) where the retiree must elect her income for the next 12 months. Ideally, one would have wanted a constant income stream, adjusting for inflation each year, but market returns are not constant, and negative returns (or very low positive returns) from one year to the next may have a detrimental impact on the long-term sustainability of the plan. Thus, retirees should be able to change their expected income levels as portfolio values may decline from one period to the next.
Source: Optimal withdrawal rates