There is this strange phenomenon in SA called Regulation 28 that is applied to retirement funds. It stipulates that retirement fund members may not have more than 75% of their funds in equities and no more than 25% of the fund invested offshore Continue reading A case for higher offshore weighting within a living annuity?
A client of mine presented a potential dilemma to me. He has a living annuity through Liberty Life but also has the bulk of his living annuity funds on a LISP platform. He was wanting to move the Liberty one to the LISP and consolidate his investments on one platform*.
Under normal circumstances there should be no penalty when transferring living annuities. However, in the fine print, Liberty had noted that there would be an exit penalty if the annuity was transferred anywhere else within the first 5 years of the investment. As such he was advised that he was going to pay a penalty of 1.2% (±R6500) to move his annuity and he balked at the prospect.
We told him to find out from Liberty what the total annual fee on his annuity is and it turns out that they are charging him a total of 2.15% pa (admin and fund fee, no advice fee included – the advisor took that maximum upfront fee).
By comparison his living annuity on the LISP has a total annual fee of 1.1% (fund and admin fee, no advice fee). Do the maths – the 1.2% penalty will be covered in the next 12 months and thereafter he will be better off because of the lower annual fee (less than half of the current annual fee and there would still be a penalty to move for the next 24 months).
The real question I have for him is why anyone would ever invest in a product where there is any kind of exit penalty? There is no need to ever pay penalties when it comes to investing – there are far better (and cheaper) products out there than those offered by the life insurance companies. Stay away from them unless it is insurance you need!
*Note: he pays us directly for advice and there are no on-going advice fees on his investments so the advice we give to him is not affected by the desire to grow assets on which we earn fees.
Living annuities have received a lot of press in the past while and much of it has been critical of the product (sometimes rightly so). The issue has mostly been around the erosion of income because of poor fund selection and an income draw that is too high and thus not sustainable. This has resulted in ASISA producing a revised code for Living Annuities that was introduced in Sep 2010. The intention is noble but in my opinion, the added “disclosure” is far from clear and it could have been done in a more user-friendly manner that the average man-in-the street could understand.
But that is not the point of this post – the other kind of annuity at retirement is a life annuity – typically this is sold through an insurance company. You give them your capital and based on a few things like your mortality (age & sex) as well as interest rates, they contract to pay you an income for the rest of your life (at death the capital usually disappears – but that is not the issue here).
According to stats*, 90% of these annuities have no annual escalation on the income! This means that if you take one of these and live for 30 years, you will still be drawing the same income in 30 years time! At an inflation rate of 6% per annum an initial income of R1000 will effectively have reduced to R156 pm at that stage. Talk about erosion of income and yet nothing has been done about this by ASISA – they seem to be turning a blind eye to what is an exceptionally bad business practise and one that should have been outlawed years ago. If living annuities are subject to a code of conduct then life annuities should also be subject to one. And the first point should make it compulsory for Life annuities to have inflation linked increases on them. I cant think of any valid reason for not including one. The only possible reason is that if there is an escalation then the initial income will be lower and at “quote stage” this might not look as attractive to the client resulting in a “lost sale” and so the escalation is left off to make it more appealing (initially that is).
I have come across far too many “little old ladies” who are locked into these annuities and are still receiving the same income that they started with – they have not been “protected” against loss of income by anyone!
When you finally get to retire from your pension fund or retirement annuity you are faced with a significant (and very important) choice about what kind of annuity you will purchase (with the compulsory portion of your fund).
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:
- A single life annuity where the capital dies with you.
- An assured annuity where an insurance policy is purchased to pay out the capital on your death.
- 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).
- 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).