The National Treasury found that only 6% of South Africans will be able to maintain their standard of living in retirement.
There are two key contributing factors to this. Firstly, many people are investing in the wrong schemes and secondly South Africans are simply not saving a high enough portion of their monthly income.
South Africans should be re-evaluating their current retirement saving plans and saving at least 15% of their monthly incomes to ensure they are on track to achieve their retirement goals.
Retirement Annuities (RAs) are a great option because they give people the freedom to save money in their individual capacity instead of relying on employer funded benefits. However, if you are not vigilant in your choice of RA and the related costs, it can easily become an inflexible money trap that delivers low returns, high fees and stiff penalties.
Investors should ask the below six questions about their current RAs:
1. Will you face penalties or extra charges for cancelling or changing your RA?
Generally speaking, there are two types of RAs: The “Traditional” RA and the “New Generation” RA.
The traditional policy-based RAs are underwritten by the big life assurance companies and are usually inflexible. These RAs are long-term contracts and impose future obligations, specifying how much should be saved and for how long. If you wish to cancel or change the contract you will pay a penalty, often referred to as an ‘early termination charge’. This happens because Life Companies tend to pay the broker a life time’s worth of commissions in one upfront lump sum instead of monthly. Should you cancel your RA or reduce your monthly contribution the company will charge you a penalty in order to recoup the money it paid to the broker.
The “new generation” unit-trust based RA is offered by the asset management industry and has more flexibility built in. Here, you are not locked in – you can cancel or lower your contributions at any time and can even take an indefinite ‘contribution holiday’ without paying a penalty. This is because fees are recovered on an as-and-when basis only.
2. Do you have to pay for an intermediary or financial advisor?
Traditional RAs are usually sold through a broker and you could still be allocated a financial advisor even if you go direct. Their commission depends on the terms you have agreed to: the higher your contribution, your escalation rate, the fund fees and the investment term, the bigger your broker’s commission, which may tempt intermediaries to maximise their commission rather than your return.
This can be avoided with a new generation RA, where you can invest directly with the asset manager of your choice. The advisor (if applicable) can still be paid out of your savings, but at your discretion.
3. Are you maximising your tax benefit?
You can contribute up to 27.5% of taxable income or remuneration (tax-free) to your retirement funds (pension, provident or retirement annuities). This amount is capped at R350 000 per year. This is the government’s way of incentivising South Africans to be better savers. Spend some money on your retirement savings and you’ll either get a ‘discount’ (through higher take-home pay than you’d get without the tax incentive) or ‘cashback’ (through a tax refund). It’s important to keep in mind that you can contribute more, but you will be taxed on the amount over and above the first 27.5% or R350 000 yearly cap.
Evaluate your retirement annuity in terms of the tax benefit and, if you haven’t reached the yearly cap, you can benefit from contributing more before the end of the tax year.
4. How much are you really paying in fees, and could you be paying less?
Fees are an important consideration when choosing your RA. Over and above any advisory fee, you could also incur administration and investment management charges, platform fees and switching costs. Given the dramatic long-term impact of fees, you should ideally pay less than 1% p.a. for all these services. Many RAs (especially the traditional ones) can cost more than three times the low-cost alternative. Over a 40-year savings term, lower fees have the potential to double your pension.
5. Are you taking on the right amount of risk given your age?
Your asset mix should be risk-appropriate for your investment term: As a long-term investor, you should have high exposure to growth assets such as shares (equities) as these habitually deliver the highest return, despite intermittent corrections. Once your time horizon shortens to less than five years, increase your exposure to bonds and cash, for a lower, but more secure return. Alternatively, choose a life-stage fund that adjusts your asset mix automatically to your investment time horizon.
6. Are you with the right provider?
While these are all important considerations, the real questions are; has your service provider brought them to your attention? Have they pointed out your long-term obligations, your potential “penalty” charges, or the impact of fees? If your provider is not upfront on these points, they may not be your ideal partner.
When you choose an RA, ask yourself: does its design serve my needs, or does it serve the needs of my service providers? Remember, you take all the risk, so don’t let others walk away with the rewards.
Tracy Jensen is the Chief Operating Officer at 10X Investments.