At the recent Parliamentary hearing on how costs can ravage your retirement savings, the Life Offices' Association (LOA), which represents most life assurance companies, attempted to dismiss cheaper unit trust retirement annuity (RA) options.
The hearing was held following the publication by Personal Finance of the findings of actuary Rob Rusconi on the costs of retirement savings, which found that on average employer-sponsored retirement funds were the cheapest option, followed by unit trusts and with life assurance RAs being the most expensive.
In responding to the Rusconi research the LOA has claimed:
- The unit trust RA options were of little consequence as very few people use them for retirement saving;
- Unit trust products are mainly for lump-sum investments;
- Unit trust RA products do not have the same legal structure as life office RAs; and
- The Old Mutual Unit Trust Personal RA, which Rusconi uses to save for his retirement, is an "obscure" product and that this was the only unit trust product that he used in his research.
To me the reason why many people do not opt for the cheaper and better structured unit trust management company-sponsored RAs is simply because the products are not well marketed by the companies themselves or by financial advisers.
My information, for example, is that the Old Mutual Unit Trust Personal RA is extensively used by Old Mutual staff who leave Old Mutual or for their partners because it is the cheapest RA product.
Many financial advisers themselves do not know about these unit trust options because the financial services companies don't inform them properly.
Well, Personal Finance has done some research on your behalf.
Our first finding is that very few unit trust management companies offer an RA product. However, some linked investment service product companies (LISPs) offer an RA with unit trust funds as the underlying choices.
There are advantages to using a unit trust product and advantages to using a life assurance RA.
Remember the same legal and tax structures apply to any RA products, whether it comes under a life assurance, unit trust or LISP umbrella. These structures include:
- Tax deductibility of premiums within certain limits;
- The restriction that you may not mature an RA before 55, but must do so before age 70;
- That money saved in a RA may not be claimed by a creditor. In other words, you cannot use accumulated assets as security against a loan; and
- At least two-thirds of the proceeds on maturity must be used to purchase an annuity (pension).
Advantages of a unit trust RA:
1. Cheaper.
Rusconi's research shows that unit trust RA products are generally cheaper than the life assurance RA products. However, you will need to check this on a product-by-product basis, but I would suggest that you use at least the Old Mutual, Oasis and Allan Gray unit trust RAs as your cost benchmark.
The benchmark should be calculated on what is called a "reduction in yield". In other words, ask for the total amount you would invest for the contracted period (remember with an RA your investment must remain until at least the age of 55). You must then ask for the figure by which the total amount will be reduced by costs. This calculation ignores inflation and performance. Generally unit trust cost disclosure is at a much higher level than the life industry, particularly when it comes to understanding the costs.
The main reason why the unit trust products are cheaper is that commissions are paid "as and when" you make contributions and not upfront for the entire contract period, as happens with most traditional life assurance RAs. You must remember:
- The life assurance industry calculates commissions on most investment policies (including RAs) by multiplying the premium by a percentage (2.75 percent in the case of RAs) by the number of years of the contract. Then 75 percent of that commission is paid in the first year and the balance in the second year of the contract. So it pays your adviser to get you to sign up for the maximum number of years. There is a further problem with the payment of upfront commissions in that there is no incentive for an adviser to keep providing you with advice; and
- Life assurance RAs also, most often, have fixed-rand policy fees which add to the costs, particularly of low-premium policies.
2. Negotiable charges.
You are more likely to be able to negotiate costs, including commissions, on the unit trust products. For example, Allan Gray will knock off the three percent of your investment (lump sum or monthly) that would normally be paid to a financial adviser if you make your investment directly with the company. Commissions and charges are also normally negotiable with LISPs. The more you invest, the stronger your position to negotiate.
3. Adaptable to your financial circumstances.
One of the single biggest problems with most of the traditional life assurance RAs, is that if you do not keep paying your premiums throughout the contractual period, there can be horrendous penalties which can result in you losing everything you have saved.
For example, last week I gave the example of a reader who was saving R1 000 a month. After paying in R30 000, the reader's financial circumstances changed and the reader could no longer continue to pay premiums. As a result, the life assurance company confiscated the entire R30 000 in penalties. It is impossible to predict your future financial circumstances, particularly when RAs can have a very long contractual period (even 50 years as an extreme).
The reason for these penalties is that the life assurers recover costs for the entire period, the upfront commissions and even lost future profits.
With the unit trust products, you can vary your premiums, cease paying premiums, and add lump sums, all without penalty.
Advantages of a life assurance RA:
1. Guarantees.
Life assurance companies will provide you with capital guarantee investment options. Most of these guarantees come in the form of smoothed-bonus products which invest across all asset classes, guarantee your capital and smooth out market return volatility when providing annual returns. So, when investment markets are out-performing you may receive less, but in bad years you will receive a better annual return than investments that are directly linked to the market.
There are also capital guarantee products which invest only in cash assets. However, be warned. These guarantees only apply if you keep up your premiums for the full contract period. There are no guarantees available on unit trust products.
2. Accessibility.
Life assurance RAs are available at much lower monthly premiums than unit trust RAs. However, remember that the lower the premium on a life assurance RA, the higher the costs are likely to be proportionally.
3. Risk-adjusted investment portfolios.
Properly structured risk-adjusted investment portfolios are easier to provide through life assurance products than through unit trust RA products. The reason for this is that life assurance companies can legally use a greater spectrum of investment instruments, including derivative markets, that are prohibited in the unit trust industry.
Please note that some LISPs also sell RAs where the underlying investment choices are unit trust funds and may be nearly as cost-effective as a unit trust RA. While the unit trust management companies only provide their own funds as the underlying investment choices in their RAs, the LISPs provide a much wider range of unit trust funds in their RAs from all or most unit trust management companies.
The situation is probably best summed up by Ebrahim Rawoot, director of Oasis Retirement Solutions (Pty) Ltd, who told me this week: "Since we do not provide our brokers with large upfront commissions, we have not been terribly successful in getting them to distribute our product. Therefore, we try to encourage prospective clients to come directly to Oasis."
Now let me repeat a few warnings I have given over the past few weeks, in view of some of the rather stupid reactions I have had from some people in the financial services industry, who keep accusing Personal Finance of undermining retirement savings by exposing the high costs of many of the life assurance products.
1. It is important for you to save for retirement, unless you feel you can live on the government social old age pension of R740 a month.
2. It is important to start saving early for your retirement. The longer you wait before you start saving for your retirement, the less likely that you will be financially secure in retirement. The government provides you with encouragement to save for your retirement by allowing you to deduct your contributions from your taxable income.
3. It is important to receive proper advice based on a financial needs analysis. Your financial adviser should inform you of the full range of products that will be the most cost-effective and appropriate for your needs in a fully transparent and understandable manner.
4. You should not cancel an existing retirement product simply because of higher costs. The penalties could be prohibitive.
Unit trust management companies which have informed us that they provide unit trust RAs are Allan Gray, Oasis and Old Mutual. Stanlib, through its LISP, and Sanlam, through its LISP, Innofin, also provide recurring premium RAs with a wide choice of underlying unit trust funds. With all these products you can stop paying premiums without incurring any penalties. In your own best interests you must have your financial adviser provide you with full details of these products.
Good news
I hear the life assurance industry is now, for the first time, having a serious look at its cost structures and the effect they have on you. This follows the publicity given to the Rusconi report on costs of retirement savings by Personal Finance; the parliamentary hearing on retirement fund costs; and concerns voiced by Finance Minister Trevor Manuel and senior members of the National Treasury.
While it would be silly to expect changes overnight, I think the industry now realises that it is in a new ball park. Key players now accept that the life assurance industry can not continue to act arrogantly, deciding for us what is in our interests; and that it has to give us better value for money.
There are still some dinosaurs left, as Personal Finance found out over the past two weeks, when I was virtually accused by one company of lying to Parliament in what was part of a very blatant and nasty attempt to discredit myself and Personal Finance for making the Rusconi report public and commenting on other issues, not covered in the Rusconi report, which unfairly reduce our retirement benefits.
Correction
Last week I incorrectly stated that Abri Meiring, the chairperson of the South African Chamber of Business' parliamentary committee and Business Environment Manager at Old Mutual, had said since the 1976/77 Budget introduced tax on the interest, foreign dividends and net rental income earned by retirement funds, about R40 billion has been removed from our retirement savings.
The date is incorrect and should have read the 1996/97 Budget. In other words, the tax was paid from your retirement savings over eight years and not 28 years. The mistake was mine and I apologise.
The main point of my column last week, however, remains that the debate over retirement fund tax must not be used by the life assurance industry to detract from the debate over costs sliced off retirement savings by financial services companies. Personal Finance will deal with retirement fund tax and the impact it has on your retirement savings as a separate issue in a future edition.