Retirement annuity (RA) funds are a great innovation and they keep evolving. They are also a great vehicle to top up your retirement savings. They have moved a far way in recent years from the traditional high-cost (and therefore low-return), badly structured life assurance products that had confiscatory penalties if you did not meet contractual commitments to keep paying premiums for often up to 40 or more years.
Many people over the years have had significant slices of their retirement savings confiscated by life companies when misfortune, such as losing a job, befell them and they could no longer afford to pay all or part of the contributions.
The confiscation could be as much as 100 percent of what you had saved.
Thanks to the former Pension Funds Adjudicator, Vuyani Ngalwana, and the former Finance Minister, Trevor Manuel, that fleecing has been dramatically reduced.
In terms of a statement of intent, which the life assurance industry signed in December 2005 with Manuel, the industry agreed to limit the penalties for what are termed “causal events” to 30 percent of the accumulated value on RAs and 40 percent of the accumulated value on endowment policies bought before January 1, 2009. Causal events include reducing or stopping payment of premiums/contributions and cashing in a policy before maturity.
From January 1, 2009, the maximum penalties were reduced to a still sizeable 15 percent.
Many life assurance companies, which have resisted introducing consumer-friendly RA products, have lost market share to unit trust management companies. Since the intervention of Manuel, unit trust companies such as Allan Gray, Coronation, Investec and Oasis have come up with far cheaper and far more versatile products that allow you to increase or decrease contributions at will without penalty.
Some life assurers, such as Old Mutual, now actively market both unit trust and assurance-wrapped products, generally aiming the life products at people who need advice and the unit trust products at people who want to invest directly (see “The different types of RAs, below”).
The market continues to evolve. Next month, specialist distributor of exchange traded funds (ETFs) ETFSA.co.za, is to introduce an RA in which all the underlying investments will track one or other index or asset type. You will not be able to choose the individual tracker funds but you will be able to select from a number of portfolios, which will be structured by Nedbank Capital on a risk basis with targeted above-inflation returns.
You will be informed of the underlying components.
The portfolios will meet the investment requirements of regulation 28 of the Pension Funds Act, which enforces diversification of investments across asset classes to reduce risk.
Mike Brown, the chief executive of ETFSA.co.za, says an all-tracker RA fund has been made possible by the rapid increase in the number of ETFs available. Initially, Satrix funds were limited to equity markets. Now there are funds that track the other asset classes of property, bonds, commodities and cash, enabling the launch of regulation 28-compliant RAs.
Brown says preservation funds will be launched at the same time as the ETF RA, and the next step will be the introduction of investment-linked living annuities in which all the underlying choices will be ETFs.
ETF RAs will be cheaper than the other products on the market because the costs of ETFs are much lower than those of actively managed unit trust funds.
So you need to shop around, comparing costs and structures. Remember, you do not have to remain loyal to one product. You can even switch your retirement savings to a newer, better product of another company.
But be careful if you have an older life RA product with penalties.
THE DIFFERENT TYPES OF RAs
Retirement annuities (RAs) come in different guises, offering different solutions, cost structures, premium levels and legal structures. You are often not informed about all your choices and the consequences.
There are two main divisions: collective investment scheme (unit trust) RAs and life assurance RAs.
Generally, the life assurance RAs are the ones that come with the funnies, such as contractual periods and penalties for not meeting the one-sided contracts.
There is also a lot of mixing and matching. The main choices are:
* Unit trust RAs
The simplest and most cost-effective arrangement is a unit trust RA issued by a collective investment scheme that restricts you to investments in its underlying suite of unit trust funds.
They are entirely flexible, allowing you to make lump-sum or recurring (debit order) contributions and to stop or increase or decrease the amounts you contribute, taking account of minimum investments.
You are normally allowed to switch between the unit trust funds of a single management company free of charge. The choice of underlying unit trust funds is yours to make.
Most management companies offer what are called prudential asset allocation funds, which reduce your investment decisions. These funds come with different risk levels, mainly reducing volatility risk by being higher in cash but also reducing potential upside.
The minimum investments are often relatively high. For example one of the most cost-effective RAs currently available is the Old Mutual Unit Trusts Retirement Annuity Fund where the minimum initial lump-sum investment is R10 000 or R500 a month.
* Lisp RAs
RAs offered by linked investment service providers (Lisps) offer you underlying investment products and the ability to switch between the products of numerous asset management companies.
Most of the choices are collective investments (unit trust funds and exchange traded funds). However you may also be able to hold a share portfolio and even have access to products offered by life assurance companies that offer guarantees on both capital and investment growth.
When you select a guaranteed product there may contractual conditions that commit you to recurring premiums for a pre-determined period, normally a minimum of five years.
The Lisp products come in two main guises: life assurance products and non-life products.
The life assurance products will offer you the same wide range of underlying investments but with the possible downside of a lack of flexibility on investments, with penalties if you do not maintain recurring premiums.
To again use Old Mutual as an example, it offers three Lisp RAs. Its Galaxy RA and Investment Frontiers Retirement Capital RA funds are aimed at the top end of the market, with a minimum initial lump-sum investment of R100 000 or recurring premiums of R2 000 a month. The third is the Max RA, which is divided into what Old Mutual calls a “focused” plan and a “flexible” plan.
The main differences between the Galaxy and Investment Frontiers products are the underlying investment choices, with Galaxy offering the wider choice. Both products provide flexibility in how much and how often you want to invest, subject to minimums, but with no contractual commitments or penalties for making changes.
The Max RA offers a more limited range of choices and is aimed at the lower end of the market, with minimum investments of R250 a month for the “focused” plan and R500 a month for the “flexible” option.
The main difference between the two is that for a higher cost (which will reduce your end benefits) with the “flexible” plan you can increase, decrease and stop making payments without any penalties. With the “focused” plan you are committed to any recurring premium for a minimum of five years. Stop paying or reduce your payments and you could have 15 percent of your accumulated savings confiscated.
The upside of the life assurance products is that they offer underlying investments in guaranteed products, which often also add the attraction of investment-return smoothing. The smoothing means that if you mature your product in a bad year the value will be better than a market-linked product. The guarantees are normally on all or part of your capital, with the cost of the guarantee linked to the guarantee chosen.
* Life products
These products mainly limit you to a small range of investments, normally centred on smooth/stable bonus portfolios with full or partial capital guarantees or a market-linked balanced portfolio with a commitment to contractual payments, with penalties if you do not keep paying. An example was Old Mutual’s now discontinued Flexi RA.