The new generation RA

As with anything requiring your signature, it is absolutely imperative that you understand what you are committing to when investing in a retirement annuity. In essence, there are two vastly different types of retirement annuities available to investors. Knowing and understanding the difference between policy RAs and unit trust RAs can have a significant impact on your retirement savings. Here’s why.

Traditional, POLICY retirement annuities

As the name suggests, this type of RA involves the investor purchasing a policy with an insurance company. This policy (which is underwritten by the insurer) is, in essence, a contract in which the investor commits to contribute towards the RA until at least age 55. On selling the policy, the broker is paid a sizeable upfront commission based on the value of the premiums the client has contracted to pay. The upfront commission is effectively borrowed from the client’s future investment with interest charged. If the client wishes to prematurely cancel his retirement annuity, or can no longer afford the monthly premiums, he is charged a penalty which is then deducted from his accumulated investments. The amount that he is penalised depends on the length of the time the contract has been in force, the remaining term to maturity and the terms of the contract. Policy RAs are notorious for their distinct lack of transparency which is frustrating for investors who find it difficult to obtain information on investment performance, fees, commissions, and other associated costs such as administration and policy fees.

New generation, UNIT TRUST retirement annuities

Over the past decade, we have witnessed the growth of a new generation of unit trust-based RAs which are investment-linked. A unit trust RA is not a policy, but rather a unit trust portfolio which is owned by the investor. A unit trust RA is a much more cost-effective and flexible investment structure, generally achieving more favourable investment returns than policy RAs. Investment performance of the unit trust portfolio is tracked and all costs involved are completely transparent. In a unit trust RA, investors can enjoy full disclosure of all fees including asset management, advisor and administration fees. As the owner of unit trusts, one has the freedom to choose which funds to invest in, subject to Regulation 28 of the Pension Funds Act which limits risk exposure in retirement funds. Investors are able to increase or decrease monthly contributions with no fear of penalty, and can make ad hoc lump sum contributions at any time. The costs of investing in a unit trust RA are significantly less than a policy RA, and the difference in cost can have a considerable impact on your accumulated savings in the long term. The ability of investors to elect and switch underlying funds plays an instrumental role in the long term performance of their invested assets. In addition to this, the financial advisor on a unit trust RA does not charge upfront commission, but instead earns an annual advice fee which is a negotiated percentage of the underlying investment.

Many investors have had bad experiences with brokers selling policy RAs only to be subsequently penalised for early termination of the policy. Thankfully, in recent years, policy RAs have come under heavy criticism by the National Treasury and over the past ten years reforms have ensured that insurers limit termination fees and increase disclosure. Reforms have also made it possible for investors to transfer their policy RAs via Section 14 of the Pension Funds Act to a unit trust RA. Any investor who has maintained a policy retirement annuity but has concerns about investment performance, lack of transparency, high costs or lack of flexibility should consider transferring their investment to a unit trust platform.

However, before making a decision to transfer one’s policy RA to a unit trust portfolio, it is advisable to obtain a quote from the current insurer which will set out the cancellation fees they intend charging for cancelling the policy. Once you have this information, you financial advisor will be able to do a comparative exercise mapping your existing policy (net of penalties) against a unit trust retirement annuity over your chosen investment timeline. The short-terms costs of terminating an insurance-linked RA should be weighed up against the combined benefit of lower costs and improved investment performance over the remaining life of the RA. A seemingly innocuous difference in annual investment returns can have an enormous effect on your final retirement savings, and transferring to a unit trust portfolio should always be considered. If you’re unsure of how to proceed, bear in mind the words of Kofi Annan who said, “Knowledge is power. Information is liberating”, and seek independent advice.

Knowledge is power. Information is liberating. Find out more about your RA.

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