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FULL STORY: Asisa I
Slug:
Asisa I
Source:
Group writers SA
Publication:
Personal Finance
Headline:
Section: Personal Finance
Date: 22 May 2010
Edition:
1
Page No:
4
Author: Staff Reporter
Choosing the right pension for your retirement - Part I
When must you choose a pension and what are your options?
Over the past 20 years there has been a massive shift in retirement funding, from funds that
provide you with a predetermined pension (defined benefit funds) to funds where you are
responsible for ensuring that you will have saved sufficient money to finance your retirement
(defined contribution funds).
One of the major consequences of this shift is that you have to decide on the type of annuity
(pension) you must purchase at retirement.
Annuities are investment products that provide you with a regular income, including a monthly
pension.
Annuities can be either voluntary purchase annuities (VPAs) or compulsory purchase annuities
(CPAs).
• A VPA provides a regular income from an invested lump sum, which you accumulated by
saving using a discretionary, non-tax-incentivised investment product. You pay tax at your
marginal rate on the returns earned by the amount you invested in the annuity. You can take
out a VPA at any age for a fixed period or for life.
• A CPA must be bought with at least two-thirds of the benefits you receive from a taxincentivised retirement fund. Your pension is taxed at your marginal rate of tax.
A CPA must pay you a pension for the rest of your life. You are not permitted to invest in a
fixed-term annuity (one that pays a pension for a limited term, such as 10 years).
The types of retirement funds that require you to buy or receive a CPA are:
* A defined benefit retirement fund, where you are guaranteed a pension at retirement. With
many defined benefit funds, such as the Government Employees Pension Fund, which is the
largest pension fund in South Africa, you do not have to choose an annuity at retirement,
because the fund will pay you the pension. If your fund does not automatically provide you with
a pension, you will have to purchase an annuity with at least two-thirds of your retirement
benefits.
* A defined contribution retirement fund, where only your employer's contributions are
guaranteed but not the pension you will receive. With most defined contribution funds, you must
decide on what type of annuity you wish to buy. Few defined contribution funds provide
pensions. You must use a minimum of two-thirds of your retirement benefit to buy a pension.
* A pension preservation fund, into which you transferred your savings from a defined
contribution or a defined benefit pension fund.
* A retirement annuity (RA), which is a tax-incentivised retirement fund provided by financial
services companies. RAs are used by people who either do not belong to an occupational
retirement fund or wish to top up their retirement savings voluntarily.
You do not have to buy a pension at retirement if you belong to a provident fund, because your
contributions are not claimed against tax while you are building up your retirement savings.
One of the options you should consider with a payout from a provident fund is a VPA for life.
You should check what the rules of your provident fund allow you to do with your payout. The
rules of modern funds normally allow you to buy a pension but give you the option of
commuting the full amount to a lump sum. This gives you flexibility and helps you plan the tax
implications. If the rules entitle you only to a lump sum and you want to buy a pension with all
or some of your payout, you will have to buy a VPA after paying tax on the payout.
When it comes to CPAs, there are two basic choices of annuity:
• Guaranteed life annuities, where a life assurance company takes the risk of ensuring that you
will be paid a pension for the rest of your life; and
• Investment-linked living annuities (Illas), where you take the risk of ensuring that you will
have a sustainable pension for the rest of you life.
Peter Dempsey, the deputy chief executive of the Association for Savings & Investment South
Africa, says it is absolutely essential that you understand the various annuities and how they will
impact on your income in retirement.
He warns that no annuity can make up for a shortfall in savings. If, by the date on which you
plan or are obliged to retire, you have not saved enough money to maintain your standard of
living in retirement, you will have to continue working and saving and/or cut back on your
standard of living in retirement. Dempsey says there are other possible solutions, such as
downgrading your home. He says many pensioners are cash poor but house rich.
Dempsey says that the worst thing you can do to try to make up for a shortfall in your capital is
to use discretionary savings, such as the one-third of your retirement benefit you can commute
to cash, to make high-risk speculative investments. Many pensioners have done this - for
example, by investing in a plethora of failed property syndication schemes - only to end up
destitute.
What affects the level of a guaranteed annuity?
A guaranteed life annuity is also known as an underwritten annuity or a traditional annuity.
The key elements of a guaranteed life annuity are:
• You receive a regular pension (normally monthly) until you and/or your spouse dies. In most
cases, once you and/or your spouse have died, the payments stop. No money is passed on to
your heirs, unless a guarantee or life assurance is built into the contract.
• You pay tax at your marginal rate on the full pension you receive every month.
• Annuity rates (the pension that you receive) can differ substantially from one life assurance
company to another. In other words, different life companies will quote different pension
payments for the same amount of capital invested. You need to obtain quotations from all the
life assurance companies to see which one will give you the best deal. A variation of even R10 a
month will make a significant difference in the long term.
• Life companies take into account four main issues when they set the level of an annuity: your
age, your gender, interest rates and the type of guaranteed annuity you choose (see the
"Examples of guaranteed annuity rates" table).
1. Your age
The age at which you buy an annuity will indicate how long you are expected to live and draw a
pension.
Life assurance companies use what are called mortality tables, which indicate at what age, on
average, people are expected to die. The younger you are, the lower will be your monthly
pension, because, on average, the life assurance company will have to pay you a pension for
longer.
2. Your gender
Women tend to live longer than men, so they receive lower monthly pensions.
3. Interest rates
If long-term interest rates are high when you buy an annuity, you can expect a higher annuity
than if you bought an annuity when interest rates were low. The underlying investments of
guaranteed annuities are mainly interest-earning investments.
4 Choice
Guaranteed life annuities come with various choices and combinations of choices that affect the
rand amount of the annuity you will be paid. These choices include:
• Level annuities. You receive the same amount every month for the term of the annuity.
Your biggest threat is inflation, which will reduce the buying power of your pension every year.
When you first start to receive your pension, it will be comparably higher than the amount you
could have received from another type of guaranteed annuity. However, within a few years, due
to the effects of inflation, its buying power will be significantly lower than what you would have
enjoyed if you had selected one of the other guaranteed annuities.
• Escalating annuities. These annuities increase by a predetermined, fixed amount each year,
or the increases are linked directly to inflation.
Escalating annuities are structured to deal with the single-biggest enemy of an annuity:
inflation. Even with a single-digit inflation rate of, say, 4.5 percent a year, the buying power of a
fixed monthly pension will reduce by 25 percent every six years.
However, it is expensive to buy protection against inflation. For example, a 60-year-old man
who has R1 million to buy a level annuity could currently receive about R9 000 a month for life.
This is in contrast to the about R5 000 a month he could receive initially if he bought an
inflation-protected annuity with the same amount. However, after 13 years, the inflationprotected annuity would exceed the level annuity.
An escalating annuity may track, lead or lag the inflation rate. Most life companies will permit
increases of no more than 20 percent a year on an annuity with a 10-year guarantee, and of no
more than 15 percent a year on an annuity without a guarantee period.
It will take about nine years for an annuity linked to an inflation rate of 10 percent to catch up
with a level annuity, so you will take the pain upfront and not later on, when you may need the
additional money more urgently.
• Guaranteed and then for life annuities. These annuities can be level, escalating or withprofit. Your pension (and any increases) is guaranteed for a predetermined number of years
(normally 10 years, but it can be up to 20 years), whether or not you live for that entire period.
If you die before the end of the guaranteed period, the annuity continues to be paid to the
person (or people) you nominate as a beneficiary (or beneficiaries) for the remainder of the
guarantee period.
If you outlive the guarantee period, the annuity continues to be paid to you for as long as you
live, but your heirs will receive nothing when you die.
If you die after the guarantee period has expired, any residual capital will go to the life
assurance company.
• Capital-back guaranteed annuities. These annuities can be level, escalating or inflationlinked. They consist of two parts:
* An annuity portion. This is the amount you receive as a pension.
* A life assurance policy. Part of the total amount paid as your annuity is deducted to pay the
premium of the life assurance policy. The proceeds of the life policy will be paid to your
nominated beneficiaries at death.
Buying a capital-back guaranteed annuity (also known as a back-to-back annuity) exposes you
to paying double commission on the same lump sum, because the annuity and the life policy are
two separate life assurance contracts, unless you negotiate that commission will be payable only
on the lump sum that buys the annuity. This may provide you with an opportunity to obtain a
better premium rate on the life assurance portion.
You may need to negotiate with both your financial adviser and the product provider to get the
best deal.
• Joint and survivorship annuities. This is a structure attached to a level, escalating or
inflation-linked annuity. The intention is to ensure that the last-surviving member of a couple
will have a pension for life.
Joint and survivorship annuities are particularly important for couples where only one partner
has built up retirement savings. You can select the level of income the surviving spouse will
receive. This level will determine how much both of you will be paid as a pension.
However, you should not drop the annuity level for the surviving partner below two-thirds of the
level for both partners. It is generally estimated that it costs about one-third - not one-half less to support one person than it does to support two people, because many fixed costs, such
as rates, electricity and transport, will not decrease after one of the partners has died.
• With-profit annuities. With these annuities the initial pension is guaranteed for life, as are
any pension increases, but the increases are not predetermined.
The main features of a with-profit annuity are:
* The initial pension is guaranteed for the rest of your life.
* Pension increases are based on the profits or investment returns earned by your initial
investment, less the costs and profits of the life assurance company.
The increases are declared as bonuses. Once an increase (bonus) has been granted, it becomes
fully guaranteed for the remaining contract period of the annuity.
* The smoothing principle applies to pension increases. This means that in good investment
years, some of the "fat" is held back for the lean years. In the lean years, the increases can be
below inflation. Once markets recover, there is often a delay in granting above-inflation
increases because reserves must be rebuilt.
* The level of the initial pension is affected by what is called the purchase discount rate. The
higher the purchase discount rate, the higher the initial pension, but the lower the future
pension increases. The lower the purchase discount rate, the lower the initial pension, but the
higher the future pension increases.
Purchase discount rates vary between about three and six percent. The optimum rate is about
3.5 percent. When comparing the initial pensions offered by different product providers, make
sure you are comparing pensions at the same discount rate.
* The different investment strategies adopted by the various life assurance companies will be
reflected in their bonus declaration histories. While one company may offer you a slightly higher
initial pension, you may receive better future increases from another.
• Enhanced annuities. A few life assurance companies offer these annuities to people who,
strangely enough, can prove that they are in poor health. In other words, if you are likely to die
soon or have bad habits, such as smoking heavily, the life company will pay you a higher
pension, because you are expected to live for a shorter time. Very few life assurers offer
enhanced annuities. An investment-linked living annuity is probably a better option if you expect
to die prematurely.
Two may be better than one
One type of annuity is no better than another. The choice is a matter of what is suitable for your
particular circumstances at a certain stage in your life. You need to consider how different
retirement strategies may or may not meet your needs and wants.
In considering your options, you need to take into account numerous factors, such as the cost of
guaranteed annuities, inflation, your life expectancy, your spending patterns, the financial needs
of your spouse after you have died, the variability of investment returns and costs. Be warned:
the best (in other words, the most sustainable) income-in-retirement solution may not
necessarily be the one you want.
Research by retirement industry services provider Alexander Forbes has found that to obtain the
best results, you should consider using both a living annuity and a guaranteed annuity.
It is often better to opt for a living annuity first, particularly if you are retiring relatively young.
You should be wary of opting for a guaranteed annuity early in your retirement, because a life
assurance company is expecting that you have many years left to live and will therefore provide
you with a lower monthly pension.
But the older you are and the higher interest rates are, the more attractive a guaranteed
annuity becomes. Once you are in your seventies, a guaranteed annuity is likely to provide you
with a substantially higher pension than a living annuity, because a life company believes your
life expectancy has fallen.
Alexander Forbes has calculated the "implied yield" at different ages for a man who buys a level
annuity with R1 million. The implied yield is the annuity divided by R1 million and expressed as
a percentage. The implied yields are:
•
•
•
•
•
R93 288 a year, with an implied yield of 9.33 percent at 55;
R100 976 a year, with an implied yield of 10.1 percent at 60;
R125 134 a year, with an implied yield of 12.51 percent at 70;
R171 770 a year, with an implied yield of 17.18 percent at 80; and
R210 280 a year, with an implied yield of 21.03 percent at 85.
You must consider the following issues when choosing a guaranteed or living annuity:
• You can switch at will from a living annuity to a guaranteed annuity, but once you purchase a
guaranteed annuity, you are locked into that annuity for life. This is because the life assurance
guarantee is calculated using your average expected life span and the prevailing long-term
interest rates.
• You do not have to buy a single annuity with all your retirement capital. In terms of the law,
when the money for a split annuity is derived from the same source (for example, a retirement
fund), one annuity must have a minimum income flow of at least R150 000 a year. No annuity
from the same source of capital may be split more than four ways, and the capital value of each
of the annuities must exceed R25 000.
You can buy a guaranteed annuity and a living annuity when you retire, using the guaranteed
annuity to provide a secure source of income and the living annuity to top up your income.
• Composite annuities, which provide access to both living annuities and guaranteed annuities,
are available under a single life assurance policy. You can allocate any capital amount to either
portion, because the split annuity regulations do not apply to composite products. However,
again you will not be able to transfer any of your retirement capital from a guaranteed annuity
to a living annuity.
A composite annuity also limits your ability to obtain the best annuity rates if you switch into a
guaranteed annuity, because the package would be bought from the same product provider
within a single life assurance policy.
However, a composite annuity overcomes the hassles and costs of switching to a guaranteed
annuity.
Before purchasing a composite annuity, you should obtain an idea of the annuity rates a product
provider has awarded historically compared with other providers.
• Your state of health can have a significant impact on your choices. The two main factors that
you need to take into account are:
* Your health at retirement. If you are in poor health and/or suffer from a terminal disease, you
will probably be better off having most of your capital in a living annuity, because you will
probably need to withdraw substantial amounts for medical care. This is one time when you can
consider taking the risk of drawing down more than five percent of your capital every year.
A living annuity also means that you will not give a large chunk of money to a life assurance
company if you die a few years into retirement, as would be the case with a guaranteed
annuity.
* Dementia. Various forms of dementia afflict the elderly, and if you are affected by one of
them, you will not be competent to make the decisions required of living annuity investors. This
unfortunately exposes the elderly to fraud. If there are indications that you are suffering from
dementia, you need to consider either signing a power of attorney that puts your financial
affairs in the hands of someone you trust or purchasing a guaranteed annuity.
How to get the most out of a living annuity
Illas are flexible investment products rather than annuities, even though the purpose of an Illa
is to provide you with an income in retirement.
An Illa differs from a guaranteed annuity in that you take the responsibility - and the risk - for
ensuring that your pension will be sustainable for the rest of your life.
You must decide on the underlying investments and the rate at which you will draw down a
pension.
If you draw down too much and/or make poor investment decisions, it is unlikely that your
capital will last throughout your retirement.
Since living annuities were first marketed in the early 1990s, they have come in for much
adverse publicity. The reason is not that living annuities are inappropriate products; the
problems centred on inappropriate advice, poor investment decisions and the drawing down of
retirement capital too quickly. However, there is now a great deal more awareness of the
potential dangers associated with living annuities.
Legislation has been tightened up to give living annuities proper legal definition, particularly in
tax law. There is a statutory requirement that you must be provided with appropriate advice,
and the retirement industry has reduced some of the risks through self-regulation.
The Financial Advisory and Intermediary Services (FAIS) Act, which was fully implemented in
October 2004, requires financial advisers to be suitably qualified. The Act also requires advisers
to provide appropriate advice when they sell you or advise you on all financial services products,
including annuities.
Members of the Association for Savings & Investment South Africa (Asisa) recently adopted
another self-regulatory measure, the Standard on Living Annuities. The standard, which will be
fully enforceable from September 30 this year, is intended to ensure that "living annuities are
responsibly marketed and administered".
Despite these developments, living annuities still have potential dangers. It is important that
you understand the advantages and the disadvantages of living annuities, and when and how to
use Illas to your best advantage.
Although the providers of living annuities do not offer you any advice on selecting or switching
between investments, they are increasingly offering what are called risk-adjusted investment
portfolios or structures.
The risk- and return-adjusted portfolios are compiled by asset management experts to help
financial advisers select the most appropriate underlying investments for you.
You must take a number of issues into account when you invest in a living annuity. To get it
right, you should follow the four steps listed below.
1 Understand the product
The elements of a living annuity are:
• You must meet the legal requirements of a compulsory purchase annuity to buy a pension for
life.
• You must draw as a pension a minimum of 2.5 percent and a maximum of 17.5 percent of the
annual value of the residual capital.
• When you die, the residue of your investment will be passed on to your heirs. The residual
can be passed on as a lump sum, as an "accelerated annuity", which will pay out all the capital
and investment growth over five years, or as an ongoing annuity.
• You must choose the underlying investments. You can select and change the underlying
investments at your discretion within the basket of options offered by the product provider.
The investment choices are very wide but are based mainly on a spread of unit trust funds or
multi-manager funds that is compiled for different investment risk profiles.
• You take the risk that there will be sufficient capital to maintain your standard of living until
you die.
Understand how the product is managed
Living annuities may be marketed by banks, collective investment schemes (such as unit trust
management companies), life assurance companies and registered pension funds, but are
classified as life assurance policies.
You are entitled to switch between product providers at any stage, but you should do so only for
sound reasons, such as an increase in costs, continual inefficient service or limitations on the
investment choices.
Linked investment service provider companies (Lisps) initiated the creation of Illas in the 1990s,
and Lisps remain the main vehicles through which Illas are sold.
Lisps are essentially administrators that, according to the instructions you issue, place your
investments in, and swap them between, an array of underlying investments. Lisps also track
the performance of your investments listed on their platforms.
When a living annuity is sold via a Lisp, it is done under the life assurance licence of an
associated company, or the licence may be "rented" from a life company.
A Lisp does not provide any financial advice and very seldom deals directly with investors. A
Lisp usually insists that you deal with it through a registered financial adviser.
Lisps are subject to Asisa's Standard on Living Annuities.
Before you enter into a living annuity contract, you must ensure that you understand the
following:
• The cost structures, and any right the annuity provider (the life assurance company and/or
the Lisp) has to change the costs;
• The service levels you can expect, in particular how long it will take the product provider to
effect an instruction from you; and
• The underlying investment choices and the right of the Lisp to change those choices, and how
the restructuring of your investment portfolio will be affected.
3 Understand the risks of a living annuity
You face a number of risks in managing your retirement savings through a living annuity. The
risks include:
• Inflation risk. You will be forced to reduce your standard of living if inflation rises at a faster
rate than your investment returns (or even at the same rate).
• Advice risk. Although the FAIS Act requires that you are provided with advice of a high
standard, one of the major problems with living annuities has been the poor level of advice,
often from under-qualified financial advisers.
When purchasing a living annuity, you should consider dealing with an organisation, such as a
financial advice company or network, rather than a one-person operation. An organisation
should have a competent team of people who use sound methods to analyse investments. But
beware of what are called broker funds, which some unscrupulous financial advisers sell simply
to charge you extra fees.
The best-qualified advisers have a Certified Financial Planner accreditation from the Financial
Planning Institute. To find such an adviser in your area, go to www.fpi.co.za
• Investment market risk. You can never be sure when investment markets will rise or fall.
Living annuities are based on the annual value of the invested capital. This means you have to
take greater account of annual volatility than of average investment growth over the longer
term.
Many people who have made significant mistakes with living annuity investments have looked
only at the annual average growth of stock markets without understanding how annual volatility
and lengthy bear markets can affect their investments. The danger lies in continuing to draw
down your capital at a high rate when the market is in a slump. This will result in your having a
smaller base from which to grow your capital during the next market upturn.
Table 1 provides an example of how things can go very wrong, particularly when the initial
drawdown is high. As the table shows, the chances of rebuilding your capital at the start of year
four are virtually nil, even in a rising market. Factor in an average inflation rate of 10 percent
for the three years, and you have a real problem. Not only has the capital of R1.2 million been
reduced to R544 500, but, thanks to inflation, it now has a buying value of only R380 909.
You could have protected your capital to some extent after the market crash by reducing your
withdrawal rate from 10 percent (an income of R10 000 a month) to the minimum permissible
withdrawal rate of 2.5 percent (which would have provided a monthly income of R2 500).
• Asset class risk. The different asset classes - which include shares, interest-earning
instruments and property - have different levels of risk. For example, cash in the bank has the
lowest risk but also the lowest historical long-term returns, whereas shares have the best
historical long-term returns but the highest short-term volatility.
One way to reduce your exposure to market risk is to ensure that your underlying investments
are diversified properly between asset classes.
The Asisa Standard on Living Annuities recommends that the prudential investment regulations
of the Pension Funds Act apply to the asset allocation of your underlying investments. One of
the main limitations enforced by the prudential regulations is that no more than 75 percent of
your underlying investments may be in equities.
• Drawdown risk. This is probably the biggest risk faced by pensioners with a living annuity.
You have to decide on the level of your monthly drawdown at the start of your investment and
then review the drawdown annually. If your capital value drops, you will have to consider
reducing your monthly annuity.
Recent research has shown that if you want to be absolutely confident that you will receive an
inflation-beating pension until the day that you die, your drawdown rate should not exceed five
percent.
Only under special conditions, such as if you have other investments or suffer from a terminal
disease, should you select the maximum permissible drawdown of 17.5 percent.
Initially, the retirement industry provided indicative drawdown rates that were based on life
assurance calculations for guaranteed annuities. The problem with this is that the providers of
guaranteed annuities pool the assets and therefore the risk is shared, whereas with a living
annuity you alone bear the risk.
Asisa now provides a table that indicates the possible outcomes based on investment returns
and pension drawdowns. The table provides you with an idea of how many years it is likely to
take before you will have to reduce your pension.
For example, if you draw down your capital plus investment growth of 2.5 percent a year at a
rate of 2.5 percent, it is virtually assured that you will maintain your real (after-inflation)
pension for 21 years. However, if your drawdown rate is 17.5 percent, you will have to start
reducing your pension by the beginning of the second year, even if your investments are
earning stellar returns of 12.5 percent.
Two notes of caution:
* Be conservative when estimating your rates of return. Just because you base your calculations
on earning returns of, say, 12.5 percent does not mean that you will achieve this level. It is
better to base your estimates on an average annual return of no more than three percent above
inflation.
So, based on the Asisa table, if you earn a return of 7.5 percent and the inflation rate is 4.5
percent, which gives you a real return of three percent, and you draw down the minimum of 2.5
percent, your capital, underpinned by the returns, should enable your pension to grow in line
with, or even ahead of, inflation, practically forever. But if you increase your withdrawal rate to
five percent, it is likely that you will start to see a real (after-inflation) decrease in your income
after 19 years, even if inflation remains at 4.5 percent and you earn a return of 7.5 percent.
* Beware of volatility, particularly if you estimate a higher rate of return. The outcomes can
alter dramatically under different market conditions.
Recent research by Matthew de Wet, the head of investments at Nedgroup Investments, shows
just how the vagaries of investment markets can affect pension outcomes.
Graph 1 depicts numerous outcomes for a couple, both aged 65, with savings of R1.5 million
and a pre-tax income requirement of R10 000 a month (an annual withdrawal rate of eight
percent). The underlying investment is 50 percent in equities. The red line represents the
anticipated outcome if the markets behave in a very orderly fashion (although this is unlikely).
The blue lines represent all the actual possible outcomes, both good and bad, based on past
market performance. So, depending on the vagaries of market performance, the couple's capital
could run dry when they are aged either 75 or 93.
The graph provides a few lessons, the most important of which are:
* A living annuity drawdown rate must be reviewed annually, taking account of the investment
performance of the past year; and
* The drawdown rate should be reduced under adverse conditions.
Graph 2 illustrates the possible outcomes if the same couple reduce the drawdown rate to six
percent (the blue lines) compared with the possible outcomes if they maintain a drawdown rate
of eight percent (the red lines). Quite clearly, the possible outcomes will nearly always be better
with a lower withdrawal rate.
Nedgroup Investments has also developed the Asisa outcomes guide a little further to show how
different equity allocations in a living annuity investment portfolio can impact on the pensions of
a 65-year-old man or a 65-year-old woman. Again, these calculations are based on average
returns and do not take account of short-term volatility. Both tables emphasise that the more
you withdraw, the greater the danger of running out of money.
The Nedgroup tables differ from the Asisa table in that the Asisa table indicates the number of
years before your (rand amount) pension may start to decrease, whereas the Nedgroup tables
indicate, as a percentage, how likely it is that you will maintain a real (after-inflation) pension
for life. The Nedgroup tables indicate strongly that high withdrawal rates, rather than asset
allocation, are the main reason living annuitants run out of money.
• Flexibility risk. The ability to switch between different underlying investments may be
dangerous, because many people chase the latest best-performing investment.
Flexibility does, however, enable you to follow deliberate investment strategies to take
advantage of changes in market conditions and to move out of poorly performing investments.
It normally costs you 0.25 percent of the amount to switch between underlying investments.
This is less than the six to seven percent you would usually pay.
• The risk of planning for your heirs. Unlike a traditional guaranteed annuity, the residue of
your capital in a living annuity can be left to your heirs when you die. The capital can be paid
out as a lump sum or as an "accelerated annuity" over five years, or your heirs can elect to
continue to receive an annuity.
The capital is not included in your estate for the purpose of estate duty or executor's fees,
because your beneficiaries will pay income tax on the amount they receive.
The ability to leave capital to your heirs is regarded as one of the major attractions of a living
annuity. But in most cases, there will be little money left to bequeath, particularly if the
pensioner does not die a few years into retirement. If you base your financial plans on enriching
your children when you die, you may have to endure a financially insecure retirement.
If you are in poor health and expect to die soon after retirement, a living annuity is your best
bet, because your capital will not die with you, as it would with most traditional annuities.
4 Understand the costs
Costs for living annuities can come in layers. Costs, which include commissions/fees paid to
financial advisers, can have a debilitating effect on your investments, particularly in an
environment of high inflation and low returns. The costs include:
• Initial costs. These costs are based on a percentage of your assets that you invest and
include an initial commission. The initial costs can be as high as six percent. To some extent,
the charge will depend on the size of your investment.
• Annual costs. You will pay a percentage of your assets in costs annually. The annual costs
may include a trail commission to your financial adviser. The annual costs can be as high as 2.5
percent.
• Transaction costs. You will normally pay 0.25 percent to switch your investments.
• Layered costs. You pay a management fee on any underlying investment portfolio. Too
often, portfolios are multi-layered, multiplying the costs for each layer. A worst-case scenario
could be a broker unit trust fund of funds, with underlying unit trust funds of funds and then the
actual unit trust funds.
• Performance fees. These fees can be complex and are charged increasingly by unit trust
management companies or by companies that provide an investment portfolio, a multi-manager
portfolio or unit trust funds of funds.
You should be particularly wary of any funds of funds provided by a financial adviser, because
the costs are normally set at the maximum, even though performance tables show that these
funds, in the main, perform very poorly and are seldom able to claim their performance fees.
You should expect to pay for advice that will bring you superior investment performance. You
can and should negotiate the commission and/or fees. The commission on living annuities is
paid in numerous ways, including a (rand amount) advice fee and/or a commission based on a
percentage of your assets. The commission may be an initial amount and an ongoing amount.
International regulations are moving away from percentage-based commissions, as are
numerous local financial planners.
Complaints about poor advice
If you believe you have been badly advised about a financial product, including an annuity, that
has been bought since October 2004, you can complain to the Ombud for Financial Services
Providers, Noluntu Bam.
You can contact the ombud as follows:
Telephone: 012 470 9080
Fax: 012 348 3447
Email: [email protected]
Post: PO Box 74571, Lynnwoodridge 0040.
Website: www.faisombud.co.za