Simply put, there are 2 choices: a conventional life annuity (through an insurance company) or a “newer” Living Annuity (usually through a unit trust company). The differences are explained below…

Life Annuity: you purchase an annuity from an insurance company and they guarantee to pay you the annuity until your death when the capital “disappears” i.e. it dies with you. You have the following life annuity choices:

1. A single life annuity where the capital dies with you.
2. An assured annuity where an insurance policy is purchased to pay out the capital on your death.
3. A joint life annuity (with your spouse) where the annuity would cease on the death of the second annuitant (and the capital as well). This form of annuity is often structured so that annuity decreases by a third on the death of the first person (this allows for a greater initial income).
4. Annuity rates change on a weekly basis (according to the prevailing interest rates) and quotes would have to be obtained at the time of purchase.

Note: Most quotes do not automatically show an escalating income and it is essential that there is an escalation on the income taken – you do not want to have the same income in 10+ year’s time!

Living Annuity: you purchase an annuity from a (linked product/UT) company and have to draw an income of at least 2.5% (max 17.5%) from the capital. You take the risk in that the annuity is a function of the capital amount and if the capital is badly invested, or the income draw too high, you could erode your capital. The theory (and practice in my experience) is that as long as you have growth at a greater rate than the income drawn, you will get an ever increasing income. On your death, any remaining capital passes on to your beneficiaries who must use it to provide an income for themselves.

• You can move from a living annuity to a life annuity if you ever change your mind, but you can’t move from a life annuity to a living annuity.

Over the years, Living Annuities have received a lot of bad press (sometimes rightly so) usually because the proverbial little old lady has “lost all her money” because the money was inappropriately invested – i.e. it was put into the “wrong” unit trust funds and/or she was taking much too much income and now the capital has been eroded…

To try to combat this, ASISA (Association of Savings and Investments in South Africa) has recently introduced a standard of good practise for Living Annuities. While this might go some way to try to improve the sale and management of living annuities, what amazes me is that they have still not done anything about life insurance companies that continue to sell/market the traditional life annuities that don’t have any inflation linked escalations on the income. In other words, with this kind of life annuity, if you live for 30 years after retiring, you will still be getting the same income as when you first retired. (* see note below)

My question to ASISA (and the FSB) is this: what is worse, a badly invested living annuity or a traditional life annuity without any escalation on the income? Are they not essentially the same thing as in both cases, the investor is much worse off over time? And if so, why has there not been a move to stop the sale of non-escalating life annuities?

Note: *The (only) reason that I can see that companies do this is because the initial income looks so good, especially when compared to an annuity with an escalation on the income. For example on R400000, the fixed annuity rate is ±R3700 pm compared to a±R2200 pm on an escalating annuity. You will be better off on the escalating annuity after 10 years (infl @6%pa).

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• Client A took out an insurance based RA in 2003 (23 year term). She started a debit order of R450 pm (escalating at 10% pa).
• The current fund value is R63500
• The company claims a return of 11.8% pa on the funds but the maths shows that she has had about 6% per annum.
• She now wants to move the RA to a unit trust RA (where there is no contractual obligation and no initial fees). This will be done via a Section 14 transfer and the company can (legally) penalise her 30% of her fund value if she moves.
• Her R63500 will then reduce to R47000.
• Should she go or should she stay? What is appropriate advice in the situation?

I have not been a fan of moving this kind of policy but a quick look at the maths reveals quite a lot and has got me questioning things:

1. If she stays where she is and continues to receive 6% per annum for the next 15 years she could have ±R602000.
2. If she moves, incurs the penalty and invests the R47000 (no fees) but then gets a 10% return for the next 15 years she could have ±R802000.
3. That’s R200000 more inspite of a 30% penalty!

How could anyone not make a case that it is completely appropriate for the client to incur the penalty and move the funds elsewhere? I am pretty sure that as long as this is well documented and motivated, the FAIS Ombudsman would find no fault with this.

At issue for me are 2 things:

1. How can the insurance companies continue to claim performances on their portfolios which bear little or no resemblence to the reality on investor’s funds?
2. How can the industry still actively promote the continued selling of these awful contractual savings products, especially when there are substantially better products available. It is my contention that in years to come there will be a flood of complaints at the FAIS Ombudsman from people who have been sold these contractual RA’s instead of the cheaper and better unit trust alternate. There can be only one reason that they are still sold and that is commission!

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1. Inappropriate advice?
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In just over 1 months time it is the end of the 2010 tax year and there are 2 important deadlines that go with this. They are:

Retirement annuities:

• RA contributions need to be made before the end of Feb. This year the 28th is on a Sunday so all contributions will have to be done by the close of business on the 26th Feb in order to qualify for the 2010 tax year. But dont leave it to the last minute – get your contribution in way before that – leaving it to the last minute always creates additional and unnecessary stress.
• If you are unsure about how much you can contribute, speak to your financial planner and most important of all, make sure you are using a unit trust RA. You can get into many of them at no initial fees and you are also not contractually bound in any way (this means you can make changes to the contributions without ever incurring a penalty).

Provisional tax:

• This needs to be in by the 26th Feb as well…and this year SARS are applying “new” rules with respect to how the tax liabiity is calculated. Previously you could make a payment in Feb and top this up by the end of Sept…this year, however, you need to have paid 90% of your total tax liability by the end of Feb (you can still top up in Sept). Failure to pay 90% will result in heavy penalties…
• If you need to pay provisional tax, make sure it is in on time and even if you have a nil return, make sure that you submit the form as well.

Gregg

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For me the issue has to do with insurance companies still contractually binding people to long term contracts in this day and age. W e all know that anyone who enters into any contract is bound by the conditions of that contract and if you alter or break the contract there are penalties. This is the case with contractual insurance products such as life insurance RA’s. This is just the way that it is…However, given that the average person will change jobs many times in a working career (some stats say as many as 6 times) there is no way that any client should or could commit to binding themselves to such a contract – it is doomed to fail.

Consider the following:

Mrs Client starts working for Company A that has no pension fund and she is sold a life RA (not the better unit trust option). A year or 2 later she leaves the company and goes to Company B and they have a pension fund so she is “forced” to stop the RA because she can no longer afford the premium and there is also no longer any tax incentive to continue paying. As a result of this she will incur a penalty of up to 30% on the value of her funds.

Or on a slightly different tack, she has an RA through an insurance company and her employer decides to implement a pension scheme with compulsory membership and again she is forced to stop her RA because she cant afford to contribute to both funds. As a result she will lose up to 30% of the value of her RA. These penalties are as per the Statement of Intent (SOI) that was signed between the Minister of Finance and the Life Insurance Industry some years back.

This is just wrong! And yet insurance companies still insist on selling these products and still insist on penalising clients when they break the contract (I am still trying to get statistics from an insurance company as to how many RA contracts actually make it through the entire term but have not been able to get these yet).

As a result of the penalties that an investor in a life insurance RA is likely to incur, could he/she not make a case for “inappropriate advice” against any advisor who puts him/her into a life RA? Especially when the advisor knows full well that the client is extremely unlikely to be able to stick to the contract for the entire term and as a result will incur penalties of up to 30% each time they need to alter the contract.

If the life insurance RA was the only option then there may be some leniency that could be applied, but there is a perfectly good (if not superior) alternate product in the form of the unit trust RA where there will never ever be any kind of penalty because there is no contractual obligation to continue paying? And more importantly, the fee structure on them is completely different – there is no accounting for future earnings in today’s income statement.

Perhaps the time is coming when the FAIS Ombudsman could well find the following case of “inappropriate advice” on his desk…

“Mr Broker, you put me into a contractual product, knowing full well that I would probably not be able to adhere to the terms of the contract and that at some stage in the future I would have to alter the premium. As a result of that I will incur penalties…and all along you could have put me into a unit trust option where there are never ever any penalties…surely that was inappropriate advice”?

Perhaps the same approach will be used when the National Savings Scheme is finally introduced and many people who have RA’s will be forced to stop these as they will be obliged to contribute to the NSS and will not be able to afford to do both the RA and the NSS. At this point, anyone in an insurance RA will incur penalties of up to 30%. My thinking is that either the insurers will be legislatively forced to waive these penalties or else there could well be more than a few cases for “inappropriate advice” on the FAIS Ombudsman’s desk against advisors for putting clients into life RAs when they knew full well that the NSS was coming and that there would be penalties when the contracts were altered, especially when they could have put the client into a non-contractual (unit trust) RA.

How about it? There must be some good legal minds out there? Could a client make a case of inappropriate advice against an advisor for putting them into a life insurance RA where they have incurred penalties when there was a better product with no penalties (albeit with much lower commission) available?

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The focus has traditionally been on the financial side with little thought or emphasis being given to the emotional/psychological side of retirement. This has been largely driven by the financial services industry (insurance companies) and their focus on getting people to put money away (into their products) for retirement. If the stats are to be believed though then it has been hopelessly unsuccessful and very few (South Africans) will retire financially independent…

When the concept of retirement was first introduced (1930’s), the retirement age was older than the average life expectancy and anyone who did make it to retirement was not expected to live for more than 20-24 pay checks. These days, it is expected that many people will live for 20-30 years after retirement and some stats even suggest that some may be retired for almost half of their lives if we continue with the traditional approach to retiring at 60-65! Little wonder that few can afford it financially!

But what if we never stop working altogether? What if we just work differently or less? What if we continue working after we’ve “officially” retired? Could more of us then “afford” to retire? I recently met an 80+ year old doctor who was studying so that he could specialise further. Was he working because he had to? Nope; because he loves what he does! For him, work is not a means to an end (retirement), it is a way of life (a vocation or calling). While he can, he will always be earning – it might be less than it once was because he works fewer hours per day and fewer days per week, but in this scenario, the “huge pot at the end of the rainbow that he once needed” is no longer a necessity. Not only does he have longer to accumulate that pot, but he will also need to draw off it for a much shorter time period than someone who stopped working at 65!

It is also interesting to read that over 1/3 of male retirees in the US go back to some form of work within one year of retirement and over 2/3 of them take full-time jobs. Far too much emphasis is being placed on the financial aspect of retirement and not nearly enough is being given to the “other” aspects of retirement. Retirement is not a financial event, it is a life event and we need to plan accordingly!

That’s all for now…

Gregg

*41% of people polled said retirement was the most difficult adjustment of their lives compared to 23% who said it was parenthood and 12% who said it was marriage.

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Just read an article online about how in these tough times one of the positive outcomes is that people seem to be investing more into their retirement funds. The bad news, though, is that it is still usually too little to enable most people to retire financially secure.

Of bigger concern for me, however, is that not only are most people contributing too little, but on top of this, most people are probably not taking enough risk on their funds. This has mostly to do with the fact that most funds are completely inappropriately named or labelled.

For example, where there is individual fund choice within a pension fund, there are usually 3 or 4 funds such as the “Aggressive Fund”, the “Balanced Fund”, the “Conservative Fund” and possibly a guaranteed or money market fund. On seeing the word “Aggressive”, most investors usually panic and run for the relative safety of the Balanced or Conservative Fund (after all this is retirement money so they don’t want to risk it). Balanced Funds in this context will usually have ±50% in equities with the Conservative Funds having even less. Now we know that the best way to beat inflation (over time) is to have exposure to equities. So while they will probably not lose too much in the down cycle as a result of this choice, they will most probably also not benefit sufficiently in the up cycles.

The problem, you see, is in the names of the funds. Remember that in terms of the investment guidelines for retirement funds, you can never have more than 75% of the total fund invested in shares*…so how can that ever be an “Aggressive” fund? In the unit trust industry, funds with 75% in equities are usually referred to as Managed or Balanced Funds. So why the inconsistency in naming when it comes to pension funds?

As a result of this inconsistency, my suspicion is that not only are people not saving enough money for their retirement, but on top of this, they are also being too conservative with their fund choices and as a result of this they will have even less than they expected when they retire.

Bottom line is that if you have time on your side (at least 12-15 years before retirement) you should most probably be in the most “aggressive” portfolio that you can – this is the greatest chance you have of achieving inflation beating returns.

So remember, when it comes to retirement money, you can not, by definition, have an aggressive fund – at least 25% of the fund will be in cash, bonds and property at any stage.

*yes, I know that technically speaking there could be up to 90% in shares and property, but the reality is that this is usually not the case, with most “aggressive” funds having 75% or less in equities with the balance in bonds and cash.

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