There have been articles in the press recently debating the safe level of drawdown from a living annuity. The articles referred to work done 20 years ago by Bill Bengen , a US financial adviser who had undertaken answer the question.
He concluded that with a 4.5% withdrawal rate, increased annually by inflation, the retirement assets should last more than 30 years. He qualified the result by stating that the fund should hold not less than 55% in equities, but could hold as much as 75%.
We have in the past recommended a withdrawal rate of 5%, if you expect your money to last longer than you do. Our figure fits with his view, given that the equity returns in South Africa have been a little higher over the past century than in the USA.
ASISA, the body that regulates the unit trust industry in South Africa, has issued a standards document which matches drawdown rates to potential returns and gives the resulting lifespan of a living annuity. This shows for example that with a return of inflation +4% (after all fees) your money would last 13 years at an annual withdrawal rate of 7.5%, 33 years at 5% and in excess of 50 years at a 2.5% withdrawal.
Our typical approach has been to set up a living annuity investment to be geared to earning a return of inflation +5% over the long term. In terms of the ASISA standard the annuity should last in excess of 30 years. The equity exposure would typically be in excess of 60%.
The actual returns over the past number of years have been much higher than 5% real, so there has been no risk in the drawdown rates for most clients during this time.
The expectation is that, following bonanza returns for the first 14 years of the current century, we should expect much more muted returns going forward. After all the law of averages suggests that fat years will be almost balanced by lean years.
So it is appropriate at this time to review your withdrawal rate and also your equity exposure. You should be concerned if you’re drawing more than 5% of your capital or your equity exposure is less than 60%.
We use “time buckets” to arrange the investment of your funds. This reduces the risk of drawing an income when a market corrects downwards for a period, but it cannot cover a long term drawing rate that is in excess of what the investment is capable of producing.