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Is the retirement annuity back in vogue?

30 June 2010 Gareth Stokes
Gareth Stokes, FAnews Online Editor

Gareth Stokes, FAnews Online Editor

What is the best financial instrument for retirement savings? Long-term savers traditionally make use of retirement products such as pension funds, provident funds and retirement annuities (RAs) to reach their goals. They also make use of endowments, unit trusts or direct equity and property investments. For many years the debate around life investment products was whether the lacklustre annual returns warranted the exorbitant fees and deductions.

In recent years consumer journalists have repeatedly castigated life companies for churning investments, enticing savers with inflated returns and misappropriating interest earned on investors’ funds. Savers were particularly affected by poor surrender values on early policy terminations. The situation resulted in a memorandum of understanding (MOU) between life companies (then represented by the Life Offices’ Association) and the Finance Minister as to the treatment of RA fund member policies and other savings products offered by the long-term insurance industry. The agreement – more often referred to as the Statement of Intent (SOI) – was concluded in December 2005.

Revisiting the SOI

The SOI set out minimum standards for surrenders and early terminations across a range of life savings products, including retirement annuities (whether with or without life cover), endowments, whole life business (where the products primarily have a savings purpose) and reversionary bonus business. Future premium cessation would require LOA members to voluntarily credit to the affected policy as follows:

1. Each RA fund member policy with the value of at least 70% of the investment account of the policy at the date immediately preceding the premium cessation;

2. Each endowment policy which is made paid-up or subject to a premium reduction (i.e. policies still on the books of the insurer), with the value of at least 70% of the investment account of the policy at the date immediately preceding the premium cessation;

3. Each endowment policy that does not remain on the books of the insurer (i.e. a policy that is surrendered or lapsed) with the value of at least 60% of the investment account of the policy at the date immediately preceding the premium cessation;

4. Each qualifying whole life policy, as identified in accordance with paragraph 2.2.3, with an equivalent value as referred to in paragraphs 4.7.2 and 4.7.3 above; and

5. Each reversionary bonus policy, with an equivalent value as referred to in paragraph 4.7.2 and 4.7.3

The SOI called on life companies to view the above as the minimum standards to apply to early termination values. It also set out appropriate compensation for early termination and surrenders prior to the SOI effective date. The LOA, National Treasury and FSB undertook to implement appropriate measures to make these minimum standards binding on all members of the long-term insurance industry over time.

Stick with new generation products

The negative press mentioned earlier dissuaded many South Africans from sticking with their RA investments, and no doubt caused some residual damage to national savings in the process. Now that life insurance companies have implemented minimum termination guidelines and taken steps towards more cost effective and transparent savings products, retirement annuities – especially ‘new generation’ annuities – are back in favour. Why should you consider retirement annuities as a long-term savings tool?

Metz Press’ Paying Less Tax Made Simple series notes that “RA funds were introduced to South Africa in 1960 to give self-employed taxpayers the opportunity to make provision for retirement while enjoying tax benefits similar to those available to pension fund members.” As corporate South Africa moves to the ‘cost to company’ remuneration model the tax benefit of a RA is one of its major draws. If you’re not contributing to a company pension arrangement then you can claim up to 15% of your non-pensionable income (pursuant to certain conditions) as a tax deduction. To maximise your tax benefit you should purchase a RA with the full 15%.

Allowing for a 30% marginal tax rate this means every R1 000 invested in a RA costs only R 700! And a net return of 5% translates to a 50% return on investment! Any minor disappointments in long-term annual returns are offset by the higher capital amount. This ‘calculation’ is clearly not acceptable for the industry when publishing returns, but it certainly reflects the impact on a taxpayer using the product its full potential.

What about excessive fees?

Volumes have been written about excessive fees charged on life savings products, including sales commissions and ongoing administration charges. One of our readers recently offered this RA motivation gem: “An RA is insurance against being penniless when you are too old to earn an income!” He argued that the RA  remains the safest policy you can purchase – protected from creditors when disaster strikes – and from the member until a pre-determined retirement date. Considering these benefits a 5% charge on premium can be considered cheap!

The RA is just one of many financial instruments you can purchase to prepare for retirement. Individual savers should consult frequently with their financial advisers to invest in products appropriate for their long-term needs.

Editor’s thoughts: All else being equal the RA seems a sensible primary savings mechanism for the self-employed and for those whose companies make inadequate retirement provisions for them. Are you happy with the costs levied on and returns generated by so-called new generation retirement annuities? Add your comments below, or send them to gareth@fanews.co.za

Comments

Added by Jennifer, 12 Aug 2011
I am eager to know your response to Eric Schultz questions. if i die before retirement will my beneficiaries receive a payout or if i die early in retirement will they receive the remainder of my investment?
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Added by Eric Schulz, 17 Jan 2011
Hello Gareth, I really would like to get my hands on the rules governing RA's. Someone told me that an RA must by law pay out a guaranteed living allowance for the first 10 years of your retirement. But should you pass away on the 11th year then the capital returns to the life assurer. Surely not as the money is mine and was put there by me in the first place. Does it get paid out in a lump sum to my spouse or children? Conversely should I live to 100 the life assurer must continue paying a living allowance even if the capital runs out. Is this true? Many thanks, Regards, Eric
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Added by Sollie, 21 Oct 2010
I would like to receive this most informative bulletin, daily.
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Added by Mike, 30 Jun 2010
Why pay 5% on premiums when you can go directly to an insurer or product provider and cut out the brokerage? And please don't respond by pretending to give ongoing advice for the trail commission. This very seldom happens in practice because the advisor is too busy trying to make the next buck. People need to start taking responsibility for their own financial security and paying extra fees is not helpful in this regard. I bet you don't publish this. I had another similar response which I noticed was not published.
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Added by Dominic, 30 Jun 2010
This is an everlasting argument which will always exist. Firstly if you truly believe that going direct to either a long or short term insurer saves you money think again. You might have a slight monthly saving on your premium but guaranteed you will lose alot of money. Secondly, why use a lawyer in court when you may defend yourself? Why use a doctor when you can use google to self-diagnose. Because insurance and investments are easy? Think again. When you go directly to an insurer they have employed a qualified person to assist you, who do you believe pays their cost to company? If you use a broker then this cost is taken away and the broker charges accordingly for the advice etc.. You have good and bad Doctors, Lawyers etc etc all trying to make a quick buck or doing their best to serve their clients. It's upto you to find the correct broker. Anyway as I say this is an argument which gets rather heated and we all have our own opinions. I do agree however that the industry is now controlled and guided to a point as this protects not only the client but the insurers as well. What I find most fascinating is that on this whole article it seems that all you managed to understand and are able to comment about is 5% comm for the broker?
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Added by Koot Coetzee, 30 Jun 2010
Very informative article, but can I ask you what your opinion is on provident or pension funs refering to (your words) "the costs levied on and returns generated by so-called" provident and pension funds?
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Added by Concerned, 30 Jun 2010
"The broker is too busy trying to make the next buck", please remember that most advisors, do actually care about their clients, and that they like you, have to make a living. I have given advice to numerous clients, informing that they only need to change underlying investment funds, to experience better returns etc. Some of them view this as another scam to get more commissions, fees, as we are all usually painted with the same brush. People would rather spend money on DSTV than plan for one of the most important events of their lives! Are they really so naive to believe that it will all magically sort itself out through their company pension funds and/or government pension payouts? Cost, cost, cost; can we really not see the wood for the trees?
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