This is an `I told you so` column but it`s also one where I can tell you
that at least one company has taken steps to correct what I consider to be
a major exploitation by linked product companies and financial advisers of
pensioners.
It gives me no pleasure to say I have long warned of the dangers of living
annuities and the high risk they carry. My warnings, prior to the 1998
market collapse, were dismissed as exaggerated by people flogging this
product.
The danger is if you opt for this product you could well not have
enough money for retirement.
The 1998 market slump proved my claim. The problem is that when a market
slumps if you keep drawing down the same amount of money or even in extreme
cases when you drop your percentage to five percent of the capital value
you can seriously undermine your capital.
An example:
You invest R1 million from which you decide to draw down only five percent
a year. This amounts to R50 000 a year. The next day the market collapses
by 30 percent. Your investment amount is now R700 000. A year later the
market recovers by 30 percent. This is what happens: R700 000 - R50 000 =
R650 000.
Your capital at the start of the next year is now worth only R845
000.
For the following year, if you still want to stick to the five percent
minimum draw down, you will only receive R42 250 a year instead of R50 000.
If you want to stick to R50 000 you would now have to draw almost six
percent of your capital.
This scenario is made worse by any higher
percentage you draw down as a pension and by the length of time investment
markets stay flat or depressed.
The problem has been worsened by the wide range of investment choices given
to individuals investing in living annuities and the number of financial
advisers who have given nonsense investment advice without the required
skills. More often than not much of the advice has resulted in sub par
performance.
For this product to work you need to be receiving higher
returns on your investment than the amount you are drawing down.
Well, the evidence is now starting to come in that what I predicted is
coming to pass. People with comparatively low amounts of capital have been
shuffled into these products because of the higher commission advisers
receive.
The linked product industry has attempted to rid itself of all
responsibility by saying it merely provides the administration.
My question to the linked product industry is: Who invested in the
products, who pays the higher commissions and provides the luxury incentive
trips to exotic destinations overseas? The Financial Services Board may
also ask itself the question why it permitted such gross mis-selling and
has still not put a stop to at least the incentive trips.
My view has always been that you should not take out a living annuity
unless you can draw down at least R150 000 a year.
This amount is not arbitrary.
It is the amount that is set by the taxman
before you can have what is called a split annuity. In other words, if you
want to buy a traditional annuity to give you security and a living annuity
with the rest, you should be fine.
The good news
The good news for anyone considering what type of annuity to buy at
retirement is Old Mutual`s linked product company, Galaxy. It has
introduced a split annuity in one product.
I think the minimum investments
set are still too low but it is a major step in the right direction. Called
the Galaxy Composite Annuity it has a guaranteed annuity portion
(traditional pension) and a flexible annuity portion (a living annuity) An
overall minimum investment of R400 000 and a minimum of R200 000 in the
guaranteed annuity and R200 000 in the living annuity.
My view is that you should start by considering the absolute minimum
pension you require and invest the amount required in the guaranteed
annuity first. Then if you can meet the R200 000 minimum with the balance,
invest that in the living annuity portion.
With the guaranteed annuity portion you are given various pension options
based on the guarantees you require and on whether you require a joint
survivorship annuity for a spouse. These annuities fall into the with
profits, smoothed bonus category of product where you will receive a bonus
each year depending on the underlying investment performance of the
product.
Once a bonus is given it cannot be removed.
With the flexible annuity portion you must draw down between five and 20
percent of the capital amount each year. You also have a choice in the
underlying investments.