that will gain value as markets improve again. But when you retire and live on an income based on your retirement savings, it’s very different. When you are drawing down an income, you are reducing your capital at a far greater rate when investment markets collapse. And the longer they stay down, or even remain level, the worse off you will be.
It is important to remember that pensioners are facing the greatest dangers. And 90 percent of all pensioners choose a living-annuity vehicle rather than a traditional life assurance guaranteed annuity.
Let’s say that today, no matter how long you have been retired, you have retirement capital of R6 million. You are drawing down 7 percent of your capital a year, giving you R35 000 a month before tax. (Be warned: at an average drawdown rate of 7 percent, pensioners are already in trouble, but that is the reality of how things are in South Africa.)
The market then crashes by 20 percent, reducing your capital to R4.8 million. You stick to your R35 000 a month (R420 000 a year), because you can’t afford to live on less and you can only change the income levels on your annual anniversary date.
These tables will give you an example of what happens to your drawdown percentage if you stick to the same rand drawdown level. By year eight you are in trouble.
Table 1.1: End of year one
| Investment value | Per month | Per year | Drawdown % | ||
| Start value | R6 000 000 | R35 000 | R420 000 | 7% | |
| Market decline | –20% | –R1 200 000 | |||
| Drawdown | –7% | –R420 000 | |||
| New value | R4 380 000 | R35 000 | R420 000 | ||
| Inflation rate | –5% | –R300 000 | |||
| New totals | R4 080 000 | R35 000 | R420 000 |
Table 1.2: End of year two
| Investment value | Per month | Per year | Drawdown % | ||
| Start value | R4 080 000 | R35 000 | R420 000 | 10.29% | |
| Market improvement | 10% | R408 000 | |||
| Drawdown | –10.29% | –R420 000 | |||
| New value | R4 068 000 | ||||
| Inflation rate | –5% | –R204 000 | |||
| New totals | R3 864 000 |
Table 1.3: End of year three
| Investment value | Per month | Per year | Drawdown % | ||
| Start value | R3 864 000 | R35 000 | R420 000 | 10.87% | |
| Market improvement | 5% | R193 200 | |||
| Drawdown | –10.87% | –R420 000 | |||
| New value | R3 637 200 | ||||
| Inflation rate | –5% | –R193 200 | |||
| New totals | R3 444 000 |
At this point, the market improvement is generously provided at 8.5 percent a year (inflation + 3.5 percent growth).
Here is what happens at the end of year eight:
Table 1.4: End of year eight
| Investment value | Per month | Per year | Drawdown % | ||
| Start value | R2 181 793 | R35 000 | R420 000 | 17.5% | |
| Market improvement | 8.5% | R185 452 | |||
| Drawdown | –17.5% | –R381 814 | |||
| New value | R1 985 432 | ||||
| Inflation rate | –5% | –R109 090 | |||
| New totals | R1 876 342 |
In year eight, you reached your maximum drawdown of 17.5 percent. This is called the point of ruin, where your income will drop in real terms – and that is before inflation. In buying terms, because of inflation, your buying power would have reduced a few years earlier. Now you can see why it is called the point of ruin.
The problem with the COVID-19 pandemic is that you will never know when investment markets will recover in the longer term. For example, in nominal terms without inflation, the New York Stock Exchange took until 1952 to recover from the Great Depression of 1929, and the Japanese Nikkei stock market, whose index reached the dizzy height of 30 000 in 1992 before dropping to about 12 000, is still nowhere near that mark 29 years later.
With the SA Reserve Bank predicting a GDP rate of negative 7 percent for the year, the current market and the rand’s poor trajectory are hardly likely to see reversals during such a volatile time. Predictions are that the world average GDP growth will be negative 6 percent.
The effects are likely to be devastating for the South African economy. Tax collections are going to be dramatically down, and the government will have new debts to pay because of money it has borrowed to try to sustain the economy during the lockdown. So, with more to pay out and less money available to do so, we need to watch out for another debt downgrade.
Around the world, we are seeing a far wider reach of problems related to COVID-19 than we did with the 2007–2010 property meltdown. Unlike then, however, we now have almost every industry involved, particularly in countries that are in virtual lockdown. For example, in 2008, shops, theatres and restaurants stayed open, and people were allowed to travel, but this is not the case with the COVID-19 crisis. Investment markets will be more volatile and take longer to recover this time as well.
And it is not only the COVID-19 pandemic. We have the Saudi Arabian and Russian fuel war, which has already shrunk the oil price internationally and hit Sasol, a major contributor to the South African economy, reducing its share price by 95 percent in the first days of our national lockdown.
Solutions
Against this background, take a look at the drawdown rates for pensioners using a living annuity as a pension proposed by the industry body, the Association for Savings and Investment South Africa (ASISA), and the draft proposals by the regulator, the Financial Sector Conduct Authority (FSCA), for a Standard on Living Annuities relating to default annuities offered by retirement funds.
ASISA details how long your income is likely to last before you hit the point of ruin:
Table 1.5: Years before your income in rands will start to reduce
| Drawdown rate | Annual investment return before inflation but after costs | ||||
| 2.5% | 5% | 7.5% | 10% | 12% | |
| 2.5% | 21 | 30 | 50+ | 50+ | 50+ |
| 5% | 11 | 14 | 19 | 33 | 50+ |
| 7.5% | 6 | 8 | 10 | 13 | 22 |
| 10% | 4 | 5 | 6 | 7 | 9 |
| 12.5% | 2 | 3 | 3 | 4 | 5 |
| 15% | 1 | 1 | 2 | 2 | 2 |
| 17.5% | 1 | 1 | 1 | 1 | 1 |
Source: ASISA Standard on Living Annuities
The FSCA states in a second draft of a Standard on Default Annuities that the recommended drawdown rates for default funds by age should be as follows:
Table 1.6: Proposed default annuity drawdown rates by age
| Age | Drawdown |
| 55 | 4% |
| 60 | 4.5% |
| 65 | 5% |
| 70 | 5% |
| 75 | 5.5% |
| 80 | 6% |
| 85 | 7% |
Table 1.7: Proposed maximum default annuity drawdown rates by age
