Any industry that starts to respond to the real needs of investors and protects their interests deserves a pat on the back.
Over the years, I have been extremely critical of the way in which investment-linked living annuities have been sold. Living annuities are sound products if they are bought for the right reasons and you receive proper financial advice before investing in them. But the providers of financial products and their sales staff have mis-sold living annuities, leaving thousands of pensioners facing destitution.
The situation has been exacerbated by companies that have allowed independent financial advisers who didn't have a clue about the risks associated with living annuities, to give consumers investment advice.
When the investments went sour, the companies played Pontius Pilate, washing their hands of the problem and telling you they were not responsible for the advice provided by the independent intermediaries.
This is despite the fact that these companies entered into sales contracts with the advisers and encouraged them to sell living annuities by offering them perverse incentives, such as luxury foreign trips.
The behaviour, and the subsequent lack of remorse, by some of the biggest financial services companies in this country has been appalling.
Living annuities were introduced about 12 years ago as an alternative to guaranteed annuities (pensions). The guaranteed annuities offered were often poor value for money, mainly because you were a captive audience (you had to buy the annuities from a life assurance company). The other problem was that, in most cases, when you died, so did the pension.
Although living annuities solved some of the problems of guaranteed annuities, they created problems of their own.
There are three major risks associated with living annuities, namely:
- Longevity risk. You must draw a pension of between five and 20 percent a year. However, if you draw a pension that exceeds the returns on your investments, you are likely to run out of money before you die.
- Investment risk. If the markets fall or you make inappropriate investments, it is less likely that your pension will beat inflation or that your capital will last until the day you die.
- Advice/marketing risk. You could end up destitute if, as a result of inappropriate advice, you make speculative investments or you draw a pension that cannot be sustained by the returns on your investments.
Innofin shows the way
This week, I visited Innofin, the linked-investment services provider of Sanlam, through which Sanlam directs living annuities. Innofin provides administration services that allow you to choose a wide range of underlying investments and switch between them.
It was interesting to see how Innofin, with its range of Sanlam Personal Portfolios products, has responded to the failings in both the way living annuities have been structured and marketed and the management practices of linked-investment product providers.
Although Innofin is not the only company to have improved its practices, Innofin does provide a good example of how living annuities should be handled, the services you must demand and the issues you must consider when investing in them.
Let's examine some of these issues:
- Although Innofin will accept an investment amount of as little as R100 000, it recommends that you do not purchase a living annuity (if it is to be your sole source of income in retirement) if you have less than R1 million to invest.
Innofin also emphasises that you should not regard a living annuity as a way to recover a shortfall in your retirement savings by making speculative investments.
- You should not set the initial amount you draw as a pension at more than inflation plus one percent. In other words, based on the current average rate of inflation, you should be drawing a pension of between five and six percent of the value of the
capital invested in the annuity.
If you require a higher percentage, Innofin recommends that you consider buying another type of annuity, because drawing a higher percentage reduces the likelihood that you will have sufficient money to last until the day you die.
- Health warnings. Innofin's marketing material contains clear warnings of the risks of living annuities.
Nevertheless, I believe that Innofin - and all other linked product com-panies - need to emphasise even more strongly that equity markets are particularly volatile. If all your investments are in equities and there is a dramatic fall in the markets, your capital may be severely depleted and/or you will have to reduce your income level considerably.
- Innofin provides investment options that enable you to take advantage of various market conditions. These options include:
Selecting your underlying investments from the full range of unit trust funds. Many linked investment companies restrict your choice of unit trusts (sometimes on the basis of whether or not the unit trust management company has paid the linked investment company a rebate).
A range of risk-profiled multi-manager funds, which are managed by various fund managers, including Sanlam Multimanagers.
A combination product that allows you to switch from a living annuity and into a traditional guaranteed annuity.
In the current low-interest rate environment, you should avoid buying a traditional guaranteed annuity, because you will be locking into a lower pension for the rest of your life.
The better option is to invest in a living annuity (using conservative underlying investments) and then consider switching to a guaranteed annuity when interest rates move up (as they surely will), so you lock into the higher rates at the right time.
Direct investments in shares and bonds (gilts), thereby avoiding the need to use unit trust funds.
Although you need fairly large amounts of money to invest directly in bonds (R250 000 or more), you are able to enjoy the benefit of interest rates offered directly instead of buying a guaranteed annuity (from a life assurer), where your money is mainly invested in bonds.
The new RSA Retail Bonds are excluded, because only individuals can invest in them. Although a living annuity allows you to select the underlying investments, by law you do not actually own the underlying assets. The life assurance company under whose name your annuity is issued owns the assets.
- Sanlam only accredits advisers who have written examinations set by Sanlam to sell its living annuities.
Innofin makes it a condition that you invest through a financial adviser. To me, this condition is wrong. Some pensioners have the knowledge and the time (particularly in retirement) to manage their financial affairs. If you are one of those people, you should negotiate a straight fee (based on an hourly rate) to pay an adviser to facilitate the transactions. Even if you need some advice, you should again negotiate an hourly fee.
Paying an adviser a fee based on a percentage of your assets - which can be as high as one percent annually - is simply ridiculous and undermines your standard of living.
Look at it this way: If you have invested R1 million and are drawing a pension equivalent to five percent a year, you are receiving R50 000 and your adviser is receiving R10 000. And that R10 000 does not include the other costs, which can add another 1.5 to three percent to the total.
The insistence by many financial services companies that you invest through a financial adviser is completely unacceptable, particularly when these companies (unlike Innofin) do not require the advisers whom they contract (license) to sell their products to possess even a modicum of knowledge. And then, when your investments go pear-shaped as a result of the bad advice you received, the companies tell you it is not their problem, but yours.
Definitions
Guaranteed annuity:
This is a pension that is normally paid until the day you die. The amount of the pension is guaranteed. In most cases, when you die your estate and beneficiaries obtain no benefits. Guaranteed annuities are available in various structures, including level payments, escalating payments to pace with inflation and as joint and survivorship annuities, where the pension (or a proportion of it) will continue to be paid to a spouse after the annuitant (pensioner) dies.
Investment-linked life (living) annuity:
This is an annuity (paid as a monthly pension) based on a percentage (between five and 20 percent) of the underlying capital. The annuitant takes the risk that there will be sufficient capital to provide an adequate pension until death. On death, the pension can continue to be paid to your dependants for life or they can receive it as an accelerated annuity over five years. The annuity is not included in your estate for estate duty purposes.