In today's environment of low interest rates, many pensioners are turning to living annuities to boost their incomes. Linked-investment service providers (Lisps) are the main purveyors of living annuities. We explain how Lisps work and how they can help or hinder your plans for a secure retirement.
Every month, millions of rands pour into the coffers of linked-investment service providers (Lisps). Most of this money is the retirement savings of millions of South Africans.
The first Lisp was launched in 1986 by the now- defunct UAL Merchant Bank in response to the move from defined benefit to defined contribution retirement funds and pressures from investors who were fed up with the lack of choice, versatility and disclosure offered by life assurance companies.
With most defined benefit funds, your pension is paid by your fund on the basis of a formula, with the employer providing the guarantee that the pension will be paid for the rest of your life. But with defined contribution funds, the employer has no obligation to provide a pension. The result was that pensioners wanted control over their money if they were to take on the risk of not being able to provide themselves with a pension.
The only alternative until UAL entered the investment scene was to purchase a guaranteed annuity from a life assurance company.
But this came with its own problems. Many people did not like the idea that when they died they "lost" their capital, and they had no idea of the underlying investments and costs. In other words, they had no inkling whether they were getting a fair deal.
There are now 16 members of the Linked Investment Service Providers' Association (Lispa), and they administer more than R200 billion involving 350 000 contracts.
In recent years, low interest rates have provided Lisps with a major boost to their business. More and more people reaching retirement are turning to investment-linked living annuities (Illas) as at least a short-term solution to the current low interest rates.
Lispa chairman Riaan van Dyk says R10 billion a year pours into Lisps from Illa pensioners.
The problem facing anyone retiring today is that the low-risk, guaranteed pensions (based on current low interest rates) lock you into a comparatively low pension for life. And the younger the age at which you retire, the lower the guaranteed annuity.
Lisps, with their Illas, provide a solution to the low-interest-rate conundrum, but you must be aware that all Lisps are not equal. You need to take care that you understand what a Lisp does, exactly what products and services you are being offered and at what price, and the risk that you may not have a sustainable income throughout your retirement.
Personal Finance has compiled a list of 10 things you should know about Lisps and what they offer you, particularly as an Illa pensioner.
1. What is a Lisp?
A Lisp is an administration company that provides you with three services:
- Access to most, but not necessarily all, the available unit trust funds and shares, as well as other specialist investment portfolios and products;
- The ability to move between underlying investments, normally with 48 hours' notice; and
- Regular statements on the state of your wealth. The statements will tell you the names of the products in which you have invested, if there has been any traffic in your investments over the reporting period, the value of your investments and details of any costs and/or tax deductions.
Lisps started as unit trust fund supermarkets. And although they have become a lot more complex and now offer a much wider range of investment products, they remain investment supermarkets. Lisps do not provide advice or their own investment products. (Some Lisps, however, do provide advice assistance to financial advisers.) You visit the Lisp supermarket (normally via a financial intermediary) and choose the underlying funds in which you want to invest. The Lisp also facilitates switching between unit trusts, at a fee of 0.25 percent of the value of the amount being switched in lieu of other entry and exit costs.
In short, Lisps are intermediaries between you, as the investor, and the provider of the underlying investment product. Lisps never own your money. They aggregate all the money that is invested with them that must go to, say, unit trust funds A, B and C. The money is then invested in the name of a custodian in the selected funds.
The unit trust management company or companies do not know the names of all the individual investors. The Lisp keeps track of what money invested in which unit trust fund belongs to which investor.
Before the advent of Lisps, if you wanted to switch between unit trusts, you had to sell your units in one fund and apply and pay for the units of another fund - and incur new costs. These costs could have been as high as seven percent of the value of your investment.
Many Lisps are associated with either life assurance or asset management companies that offer investment portfolios to meet the particular demands of investors within the Lisp environment. This is similar to a supermarket offering its own-name products.
2. The legal structure
Lisps are required to register with the Financial Services Board (FSB) in terms of the Financial Advisory and Intermediary Services (FAIS) Act. In the terms of the registration, Lisps have to meet a number of obligations, including submitting annual audited statements to the FSB showing that they are solvent.
The first Lisps on the scene were stand-alone companies, such as the now-defunct TMA, and asset management companies, such as Investec.
When the first Lisps entered the market, life assurance companies, which permitted investors to invest only in the products they offered, started to lose business. Initially, the life industry attempted to discredit the Lisps, warning investors that costs were high and they were shouldering too much risk.
However, as the life assurers continued to lose market share, particularly in the single-premium investment market, they were forced to come to the Lisp party. The life companies have effectively combined the Lisp structure with their product offerings, providing you with a choice of their own investment products managed by their own asset managers, as well as the offerings of other investment product companies. These products tend to be sold under a life assurance policy, which is subject to the Long Term Insurance Act.
Now, you have Lisps and life assurance companies that offer Illas. In the case of the latter, you receive the administration services of a Lisp and are provided with investment products by the life company. The consequence of this is that you may be signing up for a different legal contract from that of an ordinary Lisp. With a stand-alone Lisp, you own the under-lying investments, whether they are unit trust funds, shares or bonds. Life assurance companies, however, take ownership of your money when you invest with them. They offer you a return on your money, but do not actually have to invest the money where you say it should be invested. In practice, however, the money is invested where you want it to go.
3. The product wrappers on offer
Lisps offer a wide range of what are called product wrappers. A product wrapper is a structure that allows you to make underlying investments with different tax and other legal implications.
Product wrappers are provided to cater for the build-up and drawdown stages of individual financial plans, as well as for legal structures and wider product ranges. The main product wrappers are:
- Legal wrappers
These are product wrappers that are governed by laws such as the Income Tax Act, the Long Term Insurance Act and the Pension Funds Act. They include:
- Retirement annuity funds.
Unlike traditional life assurance retirement annuities (RAs), where the underlying investment is a life assurance policy, the Lisp product wrapper lets you decide on the under-lying investments.
Although new-generation life assurance products now offer similar ranges of underlying investment choice, the life assurers' recurring premium products may still come with penalties if you reduce or stop paying your premiums. The pure Lisp products are fully versatile, allowing you to alter your contributions without any penalties.
Like any other RA, your contributions are tax deductible up to fixed limits; you may not make any withdrawals before age 55; and at maturity you must use a minimum of two-thirds of the amount to purchase a monthly pension (annuity).
- Preservation retirement funds.
These are wrappers that allow you to protect the tax advantages of retirement savings. For example, if you quit an employer and do not wish to leave your savings in the employer-sponsored pension fund and become a deferred pensioner of the fund (the cheapest option), you can transfer your money to a preservation fund without having to pay any tax. If you withdraw your money as cash lump sum from an employer-sponsored fund, it will be taxable.
Your savings must remain in the preservation fund until the retirement date that was set by the fund from which you moved your money. You are permitted to make one withdrawal (which can be all or part of the amount) from a preservation fund, but it will immediately be subject to tax.
In a Lisp preservation fund you can select the investments and later switch between them.
- Illas.
An Illa is purchased with money from a tax-incentivised retirement savings plan, namely an employer-sponsored pension fund, a preservation fund or an RA fund. You are required to use at least two-thirds of the money from any of these pension funds to buy what is called a compulsory purchase annuity. With an Illa, you must draw down a pension of between five and 20 percent of the annual value of the fund (after the deduction of costs and tax).
- Non-legal wrappers
These are discretionary investments. The advantage of using a Lisp savings plan is that you can switch between underlying investments at minimal cost and have an administration company help you with things such as tax, particularly capital gains tax. You would face much higher costs if you invested directly in the products of one product provider and wanted to switch to another product provider.
- Savings plans.
These are plans where you can make discretionary contributions either as a lump sum or on a regular basis.
- Income plans.
These are wrappers that permit you to make an investment and draw down a regular income. Some of the Lisps, through associated asset management companies, also offer "guaranteed" products to provide a defined income.
4. How to access a Lisp
Most Lisps will accept investments from you only if you go through a financial adviser. The financial adviser must be registered with the FSB as a financial services provider.
But an increasing number of Lisps are prepared to allow you direct access to their services, particularly if you have significant sums of money to invest. If you are allowed to access a Lisp's services directly, you will probably be required to sign indemnities to protect the Lisp from the consequences of you not having obtained professional advice, particularly if you will be receiving an Illa. (Refer to the table "How the Lisps shape up".)
- See the second half of this story '5 Risk of bad advice' as a 'related article' below.
This article was first published in Personal Finance magazine, 2nd Quarter 2007. See what's in our latest issue