How much income should you be drawing after retirement?

The debate about how much you should withdraw from a living annuity is important if you are retiring soon (or if you are already retired) and want to know how much income your retirement savings will support. The accepted thinking is that if you want to ensure that your savings will sustain your income throughout your retirement, it is safe to start with an income withdrawal of four percent or less of your saved capital in an investment-linked living annuity (ILLA) and increase this income by the rate of inflation each year.
 
The aim of setting a safe withdrawal limit is to ensure that you do not draw so heavily on your retirement savings – particularly when the market is down (or if inflation is up) – that your capital cannot sustain your income throughout your retirement.
This popular 4% drawdown rule originated from the United States and is deemed to be appropriate for South Africans too, according to Allan Gray (Moneyweb, January 2015). Note that in South Africa, the rule of thumb has always been that you need as much as 6% to maintain nominal capital value. However, going forward in a low-return environment, the US 4% rule seems to be more realistic. Sticking to this 4% rule should provide you with an almost 100-percent certainty that you will be able to maintain that level of income in real (after-inflation) terms for 20 years and a 93-percent certainty that you will be able to maintain this income level in real terms throughout a 30-year retirement.
The challenge of course is that while a 4% drawdown will ensure your retirement savings lasts, it might be difficult to eke out a reasonable living standard if you’re accustomed to a higher drawdown rate.
If you keep 55 percent of your investment in equities and, at retirement, start with an income of four percent of your savings, and increase your income by the inflation rate each year, you should have the best chance of being able to maintain your income in real terms over 30 years, even through a number of market ups and downs.
However, withdrawing just one percentage point more – that is, five percent of your retirement capital – and increasing this income by the inflation rate each year will result in only a 64-percent probability that you will be able to maintain your income in real terms for more than 30 years.
A 5% withdrawal rate will increase your initial income by 25 percent, but if you increase this income by inflation each year, there is a 7% chance that your capital will run out within 20 years. So it is important to work out your life expectancy with your financial advisor.
In determining the safest maximum withdrawal from a living annuity, one would also need to take into account the extent to which the market delivers returns, as well as the valuation (price) of the shares and bonds at the time you invest your savings into a living annuity.
Valuation is the price of an investment relative to its earnings or yield, and the higher the valuation (price) when you invest, the lower the returns you can expect and, as a result, the less you should be able to withdraw as an income. So depending on the dividend and bond yields at the time you invested, your safe maximum drawdown rate could be much lower than 4%. It is important that your financial advisor works this out for you.
It is interesting to note that a withdrawal rate of four percent is well below the current average annual drawdown of South African living annuity investors. Statistics released recently by the Association for Savings & Investment SA shows that ILLA pensioners are withdrawing an average of as much as 6.63 percent a year. With returns across all asset classes looking to be lower for 2015, it is important to reconsider this ‘safer drawdown percentage’.
Additional sources of income
Another way for living annuity pensioners to supplement their income is to invest in underlying investments that produce a source of growing income. This can be achieved by investing in a portfolio of shares and listed property counters that produce reliable dividends and grow their dividends annually at least by inflation. Such a portfolio is designed to produce higher returns with lower volatility over time, but provide less guarantees than annuities.
 
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