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A T-day dividend in store for brokers

04 March 2021 Gareth Stokes
Karen Wentzel, head of annuities at Sanlam Corporate: Investments

Karen Wentzel, head of annuities at Sanlam Corporate: Investments

Brokers and financial advisers could be in for a T-day dividend if they position their practices to offer advice to the thousands of provident and provident preservation fund members who will soon need financial advice at retirement. Changes introduced by the Taxation Laws Amendment Act (TLAA) 2021 will eventually level the playing field across the retirement funding industry. And that means the rule requiring retirement fund members to spend two thirds of their accumulated retirement capital on a pension will apply to provident and provident preservation fund members too. National Treasury has taken steps to allow a transition to the new rules that are in force from 1 March 2021, also called T-day.

Ensuring improved retirement outcomes

We attended a presentation to learn more about annuitisation and the impact of T-day. Karen Wentzel, head of annuities at Sanlam Corporate: Investments, observed that the T-day reforms offered a great opportunity for brokers and financial advisers to connect with their clients. She commented that T-day was the latest development in Treasury’s ongoing drive to promote better outcomes in retirement. Your clients, who already benefit from the favourable tax treatment of retirement fund contributions and the introduction of affordable annuitisation options under regulation 39, will now also benefit from consistent treatment upon retirement regardless of which regulated savings instrument they use. 

From 1 March 2021, members of provident and provident preservation funds will, subject to the legislation, be limited to withdrawing one third of their accumulated fund balances upon retirement. They will have to use the remaining two thirds to purchase a pension. Wentzel explained the consequences from a fund administration perspective: “From 1 March your provident or provident preservation fund statement will have to show two balances, namely the member’s vested and non-vested share”. The vested share that reflects at T-day will be ring-fenced from the rule change. This sounds complicated, but it becomes clearer as we consider intended outcomes. 

Non-vested vs vested share

For members younger than age 55 at T-day, the vested share includes their accumulated fund balance plus any returns on that balance until retirement. The entire balance on the member’s vested share will be treated under the rules that existed before T-day. The vested share balance can be withdrawn in cash at retirement. Any contributions made after T-day, and the returns on these contributions, will fall into the member’s non-vested share, and be subject to the changed rule. These members will also be able to withdraw the full balance on their non-vested share provided that balance is less than R247500. Non-vested balances greater than R247500 can only be withdrawn as one third in cash, with the remainder used to buy a pension. All withdrawals are subject to taxation per the existing tax tables. 

For members age 55 or older at T-day, the entire balance on their existing provident or provident preservation fund plus returns on these balances, as well as future contributions and the returns thereon, will be part of the vested share. These fund members will be able to withdraw the entire vested share in cash upon retirement. The only caveat is that they must not transfer to a new fund. If the member transfers to a new fund, then the entire value of the transfer will become their vested portion in the new fund. Any new contributions, and the returns earned on new contributions, will fall into the non-vested share and be treated in the same way as the non-vested share of an under-55 fund member. FAnews discussed the T-day rules in another newsletter titled What your clients need to know about 1 March 2021, which you can read for a more detailed discussion of the changes. 

The wonderful world of annuitisation

The TLAA will bring more South Africans than ever into the world of annuitisation. There will be many provident and provident preservation fund members who will suddenly be faced with choosing a pension product that addresses the triple dilemma of access to capital and returns and protection against risks. They must also ensure that their preferred solution addresses longevity risk, market risk, replacement risk and affordability risk. Unfortunately, none of the available products are able to address all of these concerns and risks.

Wentzel unpacked the main features of life annuities and living annuities, beginning with one of the main differences between the two. “You are allowed to transfer out of a living annuity into a life annuity; but the same is not true if you are in a life annuity,” she said. A living annuity requires the annuitant to take on both market and longevity risk. Clients who go the living annuity route are therefore at the mercy of volatile markets and face a risk of running out of capital before they die. We focus on life annuities in the remainder of this newsletter. 

A life annuity offers more security and stability because it guarantees some level of income for life. The product requires the retiree to hand over their retirement capital in exchange for an income and is designed to deplete this capital over the annuitant’s life. It does not pay over any remaining capital to an estate upon death; but the insurer must continue paying the agreed income if the annuitant outlives the capital. Clients who are new to the pension world will have to turn to their financial advisers to explain the vagaries of the life annuity market. One aspect that can be confusing is how volatile life annuity rates can be. “Those who requested quotes through the first half of 2020 could have experienced price changes of up to 10% from one week to the next,” said Wentzel. 

Volatile living annuity rates

Rates are quoted for male and female annuitants due to the significant differences in mortality experience between genders. They are based on the insurer’s expectation of longevity, the prevailing interest rate and initial and ongoing annuity expenses. Sanlam Corporate saw swings of 20-25% in the quoted life annuity rates for a married male, age 65, to earn R5000 per month. A guaranteed life annuity with a 7% escalation dropped from R1 million per R5000 of income to just R700000 per R5000 between the beginning and end of March last year. The market stabilised towards the end of April and has remained in a less volatile range since. 

Your clients can choose from four main life annuity types at retirement. These include level life annuities, guaranteed escalation life annuities, with profit annuities and inflation linked annuities. It should be noted that only a handful of insurers offer the with profit life annuity option. Life annuities are great at addressing market risk and longevity risk, because in all cases they pay an income for life, based on calculations that take place at inception. The insurer assumes all the market and longevity risk. 

Retirees are often reluctant to choose a life annuity because they want to leave some capital for their children or other beneficiaries. “There are ways to ensure that your clients get a big part of their capital back; a member can have a spouse benefit, which pays out a percentage of the pension of the main member or select a guaranteed period of up to 20 years,” said Wentzel. In the event both the main member and spouse die within the guarantee period, the remaining payments get paid to the estate. There are trade-offs. The more benefits you add to the life annuity, the lower your initial pension will be. 

The complexity in the with profit segment

The with profit life annuity seeks to balance market return risks over time. “Members are subject to market volatility in that they do not know what next year’s increase will be; but on the flipside they have a guaranteed pension for life,” It is important when buying a with profit annuity to have some indication of how the pension increase will be determined in the future, how the insurer applies the smoothing of returns and how mortality is spread. Financial advisers will have their work cut out to explain the workings of with profit annuities. Client discussions will have to cover concepts like investment participation rates (IPR), product charges, purchase rates (PRI), smoothed returns, and weighted smooth returns, among others. You may even have to explain the with profit formula used to calculate annual pension increases. 

Financial advisers will have slightly different relationships with life annuity versus living annuity clients. The former requires plenty of upfront advice; the latter will need frequent advice interactions throughout their golden years. This is because living annuitants have more say over the structure of their underlying portfolios. They can also decide how much they can draw on a monthly basis, within regulated limits. “It is important for members to be aware of what products they are in and for the spouses to be aware what benefits they will receive once the main member passes away,” concluded Wentzel. 

Writer’s thoughts:
It is staggering how many retirement fund members fail to seek financial advice before retirement day. They end up making one of their most important financial decisions at the last minute, with little time to get to grips with financial planning and outcomes. Should the law do more to force retirement savers to seek advice? And do you expect greater demand for financial advice after T-day comes into force? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].


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