2018 The Income And Growth Challenge - September 2018
2018 SEPTEMBER: THE INCOME AND GROWTH CHALLENGE
Planning strategies to consider in retirement - September 2018
The typical retiree who draws an income from a living annuity needs to plan for 25 – 30 years, can expect a relatively high inflation rate and, for at least the next 10 years, should expect relatively muted returns. The prudent planner’s response to this backdrop will include:
- moderating income drawdown rates;
- ensuring that post-retirement portfolios have the appropriate balance between income and growth assets; and
- considering the introduction of dynamic spending rules to aid the sustainability of a retirement income plan.
SELECTING THE INITIAL INCOME DRAWDOWN RATE
Drawing too high an income at the start of your retirement and/or expecting too high a rate of return is as dangerous as investing too conservatively or too aggressively.
Consider the ‘income rate and return analysis’ in Figure 6 (below). This table shows a variety of possible initial income rates, from 2.5% to 17.5%. This range represents the current legal drawdown limits applicable to living annuities. It also shows a variety of potential annualised net investment returns that may be earned, from 2.5% to 15%, in each column.
Each cell in the table represents the number of years before income (adjusted for inflation of 6%) will start to decline. Another way to think about this is how many years you have before your standard of living will start to decline in the different scenarios. At a rate of return of 12.5% p.a. (historically Coronation Capital Plus achieved 12.2% per annum since inception), any initial income rate up to 7.5% represents a sustainable income, as income will continue to grow in line with inflation for at least 50 years. However, note what happens when the expected return drops by 2.5 percentage points to 10.0%: the period of sustainability drops dramatically from 22 to 13 years at the same drawdown rate of 7.5%. But by reducing your income drawdown rate from 7.5% to 5.0%, the period of sustainability increases to 33 years.
Given our current outlook for financial market returns, it would be less than prudent for most retirees to consider initial income drawdown rates much above 5% (and then only from a portfolio with appropriate exposure to growth assets.)