Retirement annuities (RA) remain the savings vehicle of choice for many South Africans preparing for their golden years. But is the traditional life-based RA still the best option? And what are the alternatives?
There are two kinds of retirement annuity to choose from. The first is a traditional RA, which is underwritten by an insurer and offers a policy-based savings solution. An investor commits a lump sum investment for a set term, or pays an agreed investment premium - which may escalate annually - at regular intervals over the investment term.
The second is a newer, unit trust-based RA, which is offered by an investment company. This type of RA does not involve the issuing of a policy.
“Investors may choose to make lump sum or debit order contributions, but don’t have to commit to remaining in that particular RA, or to upholding contributions, for any specific period,” says Hugh Malherbe, product specialist at PPS Investments.
How do the benefits compare?
Affordability
Malherbe notes that a policy-based RA typically charges set fees upfront. “A number of costs and service charges (e.g., advice fees and servicing costs) are calculated over the predetermined investment period. This total cost is then spread out and charged in monthly instalments.”
Should an investor choose to move to a different RA, or reduce debit order contributions before reaching the investment end date, Malherbe says, all future-dated monthly fees will be billed as a termination charge. This becomes a very expensive option.
To retain investors, some policy-based RAs offer a bonus payment or loyalty reward structure. Investors receive a payment after a certain investment period and/or at investment completion.
These loyalty payments come with a catch, however, as they are typically funded by high initial fees and ongoing administration fees. And, should an investor choose to move to a different RA or reduce debit order amounts, the bonus payments are withheld.
A unit trust-based RA tends to be more cost effective in terms of fees. According to Louise van der Merwe, financial advisor for WealthUp, the price of traditional RAs increased when unit trusts became accessible to the general public.
Transparency
A policy-based RA tends to lump all fees together, making it difficult for investors to decipher them or understand the individual charges.
A unit trust-based RA offers a simpler structure, which clearly sets out the schedule for fees and investments.
Van der Merwe says that the fees included in a policy-based RA, which are usually unknown to the investor, could result in less retirement savings than the investor expected.
Flexibility
Malherbe points out that a termination charge, or foregone future bonus payments, dissuade investors from moving between products or making specific changes to their policy-based investments.
This lack of flexibility makes these RAs a less attractive option, Van der Merwe says, particularly since employees no longer tend to stay with a single company for decades.
“With a life-based RA, you are penalised when you stop contributing. Legally, they can charge up to 25% of your fund, which is a lot of money,” says Van der Merwe.
On the other hand, a unit trust-based RA, which poses no potential termination fees, offers investors the flexibility to move to a different product provider, or alter investment contributions as needed.
Malherbe says this is important when investors are faced with unforeseen events, such as an unexpected loss of income, retrenchment or other immediate financial priorities.