A few years ago, during the National Budget Speech, government put a cap of R350k pa on retirement contributions. It appears that no one at treasury has given this much thought Continue reading It’s time that treasury stopped being short-sighted when it comes to the wealthy!
I was recently approached by someone for help with her Sanlam RA’s – they are the bad, old traditional life RA’s with opaque fees, poor returns and hefty penalties if you make any changes before the term ends. It seems that Sanlam has found a way around this though with their Cumulus Echo RA where they are encouraging clients to move. The “carrot” is no penalties when the move to this RA and bonuses if they see out the term. Sounds good, or does it?
It took quite a bit of digging to find the fees on these new RA’s but after a while I found 2 pages* on the Sanlam website that say it all. The first one is the advice and marketing costs which are “hidden” behind a “more information” button. Here is what it says…
“If you prefer to select your own funds and will be investing recurring monthly payments, the following marketing and administration charge is applicable:”
|Fund value band||Yearly marketing and administration charge % of the fund value of the plan|
|First R500 000||4.10|
|R500 001 – R1 000 000||3.75|
|Excess above R1 000 000||3.50|
The fee for using internal funds is slightly lower but still far too high to make it attractive.
But I think that the most insightful part of the investigation was an example of how much an investor could expect if they used the RA (including future bonuses). “The Example is based on a monthly payment of R1000, taking into account an annual inflation increase of 6% over 25 years. It assumes an investment return of inflation plus 2% after fees.”
2% after fees? We know, that it is reasonable to expect a “balanced” unit trust fund to generate CPI+5% (after fees) over the long term (25 years). Sanlam seems to be acknowledging that their fees are so high that an investor should expect to only receive inflation+2% over that time. The loss of the 3% to fees, compounded over 25 years, will be devastating to your retirement and will result in significant damage to your ultimate fund value (bonus or not).
My advice to anyone considering the Cumulus RA is to run far away – pay the penalty for transferring away from the old RA and find a unit trust RA with an underlying passive fund – your total annual fee should come in at around 1-1.25% pa (advice fee included).
*One of the pages: https://www.sanlam.co.za/personal/retirement/savingforretirement/Pages/sanlam-cumulus-echo-retirement-annuity.aspx#Works
What if SA is where Zimbabwe was ±20-25 years ago? With the benefit of hindsight, what would the average Zimbabwean do differently? Would they have stopped investing into their pension funds and bought more foreign currency? Would they have emigrated? Would they have bonded their houses to the hilt and taken the funds offshore?
I have always promised my clients that I would not invest their funds where I am not investing myself…if it is good enough for me it is good enough for them. In the same way, I have been a massive proponent of retirement annuities (and pension funds) in SA – they have made so much tax sense (as well as estate duty sense). But what if this is all about to change? If SA goes the way of Zim then I am afraid that your pension fund in SA will be worthless. If the state re-introduces prescribed assets for pension funds, then possibly it will be better to have funds offshore. If Zuma has been paid his commission for the nuclear deal, as some are suggesting, then we are facing a bleak future and a very weak currency – then it will be better to have funds offshore.
They say you should never ask a barber if he thinks you need a haircut and unfortunately this seems to apply to fund managers and pension funds too? If you ask them if it still makes sense to invest into your pension fund in SA they are likely to answer yes – their income depends on it. But what are they doing with their own money? I’ve asked a few of them but no one is prepared to stick their necks out – I suspect that they are all moving as much money offshore as quickly as they can but no one seems to be brave enough to say this in public.
So perhaps it’s time that we had a frank discussion about the future of pension funds in SA – we might not be Zimbabwe yet but perhaps we are the proverbial frog in the pot of water and perhaps we are reaching the point where we will no longer be able to jump out? So how about it, anyone brave enough to express an opinion on this one?
The recent changes to Regulation 28 rules around retirement funds has caused a bit of “excitement” in the asset management industry and I have seen at least 2 articles making a case that the stricter enforcement of the Reg 28 rules make Retirement Annuities unattractive investments, especially for younger investors (see the article by Jan Mouton of PSG Asset Management – http://www.psgam.co.za/2011/05/psg-angle-regulation-28-amendments-reduce-attractiveness-effectiveness-for-savers/ ).
The basic argument goes around the fact that in a retirement fund an investor may not have more than 75% of his/her funds invested in equities and by default most investors tend to opt for “balanced” funds. Although balanced funds can have 75% equity exposure, most, in reality, do not and they tend to err on the lower equity side.
As a result of the lower equity exposure, a balanced fund will under-perform an equity fund over long periods of time. In fact, Mouton’s article suggests that as a result of the more “conservative” asset allocation, an investor in a retirement fund could have less than 1/3 of the money that an investor in an equity unit trust fund could have. Scary stuff indeed and certainly it sounds like a compelling reason not to use retirement annuities – especially if you are young. Or is it?
Let’s take a different look at the case and let’s assume that the chosen equity fund (outside of the RA) gives a total return of “x” over the period. Now if we use the same equity fund within the RA we could invest 75% of the contribution into this fund – the balance of the money would have to go into the other asset classes and for the purposes of this example let’s refer to that as “cash”. Over the investment term, the RA would then give the following: 0.75x + “cash”. Clearly this is less than the equity fund.
But this is where the financial planner in me comes out…
One of the primary reasons for using an RA is because of the tax saving involved. For every rand you contribute, you receive a “rebate” equivalent to your marginal tax rate. Simply put, if your marginal tax rate is 30% you will only effectively pay 70cents in every rand of the RA premium – the 30cents is the tax saving. Now if you are disciplined you can invest this amount and if we use the same equity fund used above, then over time your return will be 0.3x (or your marginal rate * x).
So your total “RA” return now becomes: 0.75x + “cash” + 0.3x.
This is equal to 1.05x + “cash” (this could be as high as 1.15x + “cash”).
Even without the “cash” portion, 1.05x > x (apologies for the maths but you should have paid attention in class!). And then it is also possible to invest the “cash” portion into a property fund – which would be significantly better than “cash” over the long term.
Now this is where the detractors of RA’s will jump up and say “yes but there will be tax on the income taken from the RA whereas there will only be capital gains tax payable on income taken from the equity fund”. You are correct and this could well be less than the income tax payable on the RA income. However, at death, there will be estate duty payable on the equity fund whereas the money in the RA will fall outside of your estate (there will also be no executor’s fees on it).
I am sure that there many responses possible to this article, not least of which would be to make sure that the voluntary money was invested via a trust but that has another whole set of implications. The point of this article was to show, mathematically, that there is still a case for RA’s.
Was doing provisional tax calculations for a client and was wondering about the effectiveness of her using an RA to reduce her tax liability. She does not belong to a pension fund and all her income is therefore “non-retirement funding”. As such she could put 15% of this into an RA before the end of February. Here are the figures:
Taxable income: R250839
Tax on this (after rebates): R44142
If she put 15% of her taxable income (R37626) into an RA then her tax for the year would reduce to R33243.
So if she spends R37626 (on herself now) she will save R10899…
She either pays R44142 to SARS and gets “nothing” or she spends R70869 (R37626 RA + R33243 tax) and gets R37626 in an investment for herself. It certainly puts a new “twist” on the “got to spend money to make money” saying and of course it’s all about cash flow.
In this instance, because of the tax saving on offer she effectively pays 71% of the premium into her RA (R10899/R37626).
“They prowl the empty streets (at night), waiting in fast cars and on foot”* looking for unsuspecting consumers. Yes, it’s that time of year again when Retirement Annuity salesmen are on out in full force. February is “traditionally” RA month as it signifies the end of the tax year and anyone needing to put money into an RA has until the end of the month to do it.
RA’s have received a lot of press (not all of it good) and as a result there is probably a great deal of confusion about whether or not they are good investments. So let’s look at a few of the “issues:
- RA’s are effectively “private” pension funds and as such they are most appropriate for people who have taxable income and who don’t belong to a pension fund. They are also great for commission earners.
- Subject to tax limits, contributions to RA’s are tax deductible – this means that for every rand that you invest, the government is effectively subsidising your contribution and effectively “loaning” you money to invest until you retire.
- Yes, RA’s are subject to restrictions and are taxed when you retire but the tax rate at retirement (i.e. after 65) is significantly lower than pre-retirement (for most people that is).
In my opinion, RA’s are great investments. However, not all RA’s are equal. Don’t ever invest money into an RA through an insurance company – you are contractually committing yourself to a long-term relationship where there will be penalties when you want to leave it. Contractually binding someone to a 30 year product is an archaic way of doing business.
Here is how the “insurance” RA works. You agree to pay a given premium, escalating at some number (inflation) for a given term. The insurance company then works out all the future “profit” from this contract and accounts for it today. As a result, if at any stage in the future, you want to adjust the premium down or reduce/remove the annual premium escalation, you mess with their profits and as a result, they penalise you for it. And very often, this penalty bears little or no resemblance to the actual “loss” of profit. For policies issued prior to 2009, the penalty is usually 30%, while for policies issued after Jan 2009, legislation has reduced the maximum penalty to 15%. Very often people have to reduce/stop their premiums through no fault of their own e.g. loss of employment, forced to join the company pension fund. In such circumstances, it is fundamentally and morally wrong to penalise the investor. But that’s the fault of the way the product is structured.
So if you should never ever use an RA through an insurance company, which RA should you use? Unit trust RA’s are a much better option – there is no contractual obligation! You pay a premium as and when you want/need to and the costs are taken off as and when you pay. You can change your mind as often as you want/need to and will never ever incur a penalty for doing so.
So why are more people sold unit trust based RA’s? The very simple answer is because of the commission structure on insurance company RA’s. Consider the following example: a 30 year old takes out an RA for R1000pm.
- Through the insurance RA they need to “commit” to a term and so they agree to pay until they turn 55 (that’s the minimum age) and agree to a 10% annual premium escalation. The commission on offer to the salesperson would be R1304.40 upfront (paid in advance) and R25pm (escalating with the increased premium).
- The same RA though a unit trust company would pay the salesperson a maximum commission of R30 per month each time the premium is paid (this will also escalate as the premium escalates).
- So while there may be little difference in the total commission paid over the term of the RA, there is an incentive to earn upfront commission on the insurance based RA…and if you have a sales target then it is pretty obvious which one you are going to favour.
To summarise then, RA’s have an important role to play in helping investors to save for retirement. There are significant tax incentives when RA’s are used correctly. A contractual based RA (such as the insurance company RA) is an archaic way of doing business – stick to RA’s where there are never any penalties for changing your mind about the premium.
*for those that remember “Squad cars” on Friday evenings on Springbok radio way back before TV in South Africa.
Ok, so almost everyone accepts that a unit trust RA is currently the best retirement annuity available in SA…(for reasons of cost, transparency and most importantly, flexibility). And while government is (apparently) intent on encouraging retirement savings, it seems that they really are only paying lip service to the issue because you can only access a unit trust RA if you are well-heeled. The very people who so desperately need to be encouraged to save cant access the best product.
The current tax limit on RA contributions is R1750 per annum (there are a few provisos to this amount) but for all intents and purposes, the average man in the street who belongs to a pension fund and who wants to supplement his retirement savings via an RA is limited to this amount (by way outdated tax limits).
But here is the problem – you cant get into a unit trust RA with this amount. You need at least R250 and in most cases at least R500. When you ask the Manco’s why they all say it has to do with bank fees and the cost of debit orders, blah, blah, blah…
Somehow the Life insurance companies manage to do it – so either their systems are more efficient or they are making an absolute killing on the products (or both).
But the bottom line is that if you dont have R500 per month to put into an RA you cant use a unit trust RA and if you want to get any tax relief and only qualify for the R1750 then you are being forced into an inferior product. Not only is the life insurance RA significantly more expensive, but it also carries significant penalties if you alter the contract at any stage.
So if you are faced with the choice of a life insurance RA or no RA then I would stay far away from any retirement annuities…
My quesiton is so where are the legislators and where is the Miniser of Finance when it matters? Seems that unlike unit trust RA’s, talk is cheap!