A relook at retirement annuities: How do they compare?
17 April 2014 | Retirement | General | Hugo Malherbe, PPS
We all know how important it is to save towards a secure retirement, and for many investors the retirement annuity (RA) remains the savings vehicle of choice when doing so. It is therefore important not only that investors ensure they are saving enough, but also that they evaluate exactly how they go about doing so.
What are the options?
There are two broad categories of RAs.
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 investment term, or is required to pay an agreed investment premium (which may escalate annually) at regular intervals over the full period of a set investment term.
The second is a new generation, unit trust based RA, which is offered by an investment company. By allowing investors to invest directly into unit trusts, this type of RA does not involve the issuing of a policy. Investors may therefore also choose to make lump sum or debit order contributions, but do not have to commit to remaining in that particular RA or upholding debit order contributions for any specific period.
A unit trust based RA offers significant benefits when compared to a policy-based RA.
A unit trust based RA is:
1. Generally cheaper
A policy-based RA typically charges certain fees upfront: A number of costs and service charges (e.g. advice fees and servicing costs) over the predetermined investment period are calculated. This total cost is then spread and charged in monthly instalments. Should an investor choose to move to a different RA or reduce debit order contributions before reaching the predetermined end date of the investment, he or she will be held responsible for settling the outstanding monthly fees set to be charged in future, as calculated at the onset of the investment. The recoupment of the outstanding fees is presented as a termination charge.
Certain policy-based RAs use a bonus payment or loyalty reward structure. Investors receive a payment after certain investment period and upon completion of the predetermined investment period. These loyalty bonus payments are typically funded by high initial and ongoing administration fees. Should an investor choose to move to a different RA or reduce debit order amounts, the bonus payments are withheld or foregone. Investors need to carefully consider the implications of these higher charges versus the benefit of future bonus payment on their final retirement savings value.
A unit trust based RA tends to be more cost effective, offering "as and when” fee structures (typically charged monthly, for that particular month only). Importantly, unit trust based RAs do not impose termination charges. Investors are therefore free to move their RAs to a different product provider or to change or reduce debit order contributions without penalty should their personal circumstances change. Administration fees are generally more competitive and investors are able to negotiate advice fees with their intermediaries.
2. More transparent.
A policy-based RA tends to lump all fees together, making it difficult for investors to tell exactly which fees they’re being charged and how much each individual fee amounts to. The comparatively complicated structure of these products may further make it difficult to understand the exact nature of the investment and all its implications.
A unit trust based RA offers a simpler structure, which clearly sets out exactly how much investors are paying, precisely what they’re paying for and how their savings are being invested.
3. More flexible.
Due to the possibility of a termination charge or foregone future bonus payments, investors in a policy-based RA are afforded less flexibility to move between product providers or make certain changes to their investments.
On the other hand, as a unit trust based RA poses no potential termination fees it offers investors the flexibility to move to a different product provider or alter investment contributions as needed. This becomes especially important when investors are faced with unforeseen events, such as an unexpected loss of income, retrenchment or other immediate financial priorities.
Should an investor wish to invest in a unit trust based RA, it is critical to ensure that the RA under consideration is in fact a new generation, non-underwritten offering. Small tweaks to old generation RAs – in some instances referred to as the "new generation” of an existing offering – may lead investors to assume that these products are unit trust based RAs. However, while the product may be slightly improved, the pricing model and restrictions placed on investors will remain largely unchanged.
An investor’s choice of RA and a careful evaluation of its features and fee structure are therefore important considerations in the retirement planning process. Ultimately, an investor’s chosen savings vehicle could have a significant impact on their overall level of retirement funding.
