Investing in a retirement annuity: What should you be asking?
26 May 2014
Hugo Malherbe, PPS
Hugo Malherbe: Executive: Product Development at PPS Investments.
For many investors, the retirement annuity (RA) remains the retirement savings vehicle of choice. It is therefore important that investors carefully evaluate the features of their RA investments and understand the full implications of their investment contracts.
According to Hugo Malherbe, Executive: Product Development at PPS Investments, there are two broad categories of RAs.
"The first is an old generation RA, which is underwritten by an insurer and offers a policy-based savings solution. An investor commits a lump sum investment or agrees to make set regular contributions (which may escalate annually) for a predetermined investment term,” says Malherbe.
"The second is a new generation RA, which is offered by an investment company and allows investments directly into unit trusts. This type of RA does therefore not involve the issuing of a policy. Investors still make lump sum or debit order contributions, but do not have to commit to remaining invested or upholding contributions for any specific period.”
Malherbe notes that unit trust based RAs are generally cheaper, more transparent and more flexible. However, he adds that despite the availability of this improved offering, many investors are still investing in policy-based products. This may be because they are unaware of the differences between the two product types, or because 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. "In such instances the product may be slightly improved, but the pricing model and restrictions placed on investors will remain largely unchanged,” Malherbe says.
What should you be asking if you want to invest in an authentic new generation offering?
1. Will I be penalised if I reduce my debit order contributions or move to another product provider?
In policy-based RAs, certain fees are typically charged upfront. Several costs (e.g. advice fees and servicing costs) are calculated for the full, predetermined investment period and this total fee is then divided into monthly instalments.
"If an investor contributes less than originally expected, he or she will still have to pay the fees that would have been charged on the higher amount, as calculated at the onset of the investment,” Malherbe says. "This is presented as a termination charge.”
In contrast, unit trust based RAs offer "as-and-when” fee structures. Fees are usually charged monthly, for that particular month alone. Investors therefore only pay for the services they’ve already received and are free to adjust their debit orders or move to a different product provider without cost.
2. Is my investment linked to loyalty structure?
Certain policy-based RAs use a bonus payment or loyalty reward structure, where investors receive a payment after remaining invested for a certain period. However, these loyalty payments are typically funded by high initial and ongoing administration fees. If an investor moves to a different RA or reduces his or her debit order, the bonus payments are foregone. Investors should therefore carefully consider the benefit of a future bonus payment versus potentially higher investment fees.
3. What is the exact breakdown of my investment fees?
"Policy-based RAs tend to lump fees together, and it can be difficult for investors to tell exactly which fees they’re being charged and how much each individual fee amounts to. The simpler structure of a unit trust based RA clearly sets out exactly how much investors are paying, precisely what they’re paying for and how their savings are being invested,” Malherbe says.
Ultimately, your chosen savings vehicle could have a significant impact on your overall level of retirement funding. It is therefore important to ensure that you access the most favourable value proposition available to you.