A Fin24 user will have to pay huge penalties to move her retirement annuity to a less expensive option. Will it be worth it?A Fin24 user writes:
I have a retirement annuity (RA) with Liberty and the costs of that policy are quite high. There are admin fees, management fees and a 10% share of the growth.
It was a policy I took out when I was much younger and more naïve. I have had it for approximately 10 years now.
I also have an RA with Allan Gray. I much prefer the Allan Gray RA, which is much more transparent in terms of the costs, and their profit is set against a benchmark performance – as opposed to just taking a percentage off all growth as the Liberty policy does.
Unfortunately the Liberty policy will cost me R42 000 in penalties to do a “section 14” and move to Allan Gray. The Liberty policy is worth just over R 400 000 at the moment.
I can’t decide whether to keep the Liberty policy – I am also locked in to a R5 300 monthly payment. If I want to stop paying this, I will also have to cough up a penalty of R45 000.
So, it will cost me either to move it or to stop contribution.
So my choices are to either continue to contribute to this Liberty policy, which I am not really happy with, or bite the bullet on the R42 000 now and move it to Allan Gray or some other more transparent offering with a lower total expense ratio (TER).
Is it better to lose this R42 000 now or not?
Gregg Sneddon, an accredited financial adviser with Cape-based The Financial Coach, responds:
As I see it, the issue is around whether or not it is worth taking a (substantial) penalty on a life insurance-based retirement annuity to do a Section 14 transfer to a unit trust retirement annuity.
Firstly, a bit of background.
With a retirement annuity through an insurance company you effectively enter into a contractual agreement to pay a given premium (with/without escalation) for a given term.
As a result of this, the insurance company calculates all its future profit from your RA and accounts for it then and there.
If at any stage in the future you alter the agreement negatively (ie reduce the amount or term or escalation) then their profits will be affected and as a result they penalise you.
They also used to work out all the fees and commission on the product and pay this to themselves and the adviser upfront. Investors were also charged interest against these fees.
As a result of the high fees coming off upfront, the RAs didn’t really attain any real values in the first few years and when investors cancelled them there was very little if any value.
Much has changed in recent years and companies have been forced to give values to the policies much earlier. They have also been forced to reduce the penalties that are charged on cancellation or alteration of the RA.
The commission paid on these is also now lower.
This is a very simplistic explanation of things but it will suffice.
With a unit trust RA there is no contractual agreement – you pay a premium and each time you do, units are bought for you.
If you need to stop the debit order then you can – there are never any penalties, ever.
The units stay yours until you retire from the fund. There is complete transparency and flexibility on these RAs but unfortunately, there is (was) also significantly less commission to be earned upfront and as a result, any target-chasing salesperson would sell a life RA every time as opposed to the unit trust option.
(Don’t blame the advisers, blame the way they were incentivised and also the product structure of the life RAs).
In recent years, investors have become more aware of the costs of these products and also much more aware of the perceived poor performance of many of the life insurance RA funds.
Some of this perception around performance is unwarranted but in many cases it isn’t, especially when compared to the performance of many unit trust funds.
I think the major fault of the insurers has been their lack of transparency around performance and costs, as well as their lack of flexibility with respect to fund choices.
Some of that has changed, but not enough - and as a result many investors are wanting to move their RAs away from the insurers.
Mathematically, you could probably make a really good case for doing this, even when you take the high penalties that are being levied into account.
So any adviser or client who does the maths could probably justify the move. However, I still think that the penalties are too high and I have a hunch that they may be reduced totally in the not-too-distant future.
My reasoning is as follows:
When the National Savings Scheme (government’s planned new compulsory retirement savings plan) comes into effect, it is predicted that we will all have to contribute to it.
Many people will not be able to afford to contribute to the scheme and continue their RA investments.
As a result they will be “forced” to stop contributing to the RAs and will suffer significant penalties.
My thinking is that either the insurance companies will be compelled through legislation to reduce or waive penalties – or else there could be a very long queue of complaints about inappropriate advice at the FAIS (Financial Advisory and Intermediary Services) Ombud’s door.
The complaint could go something like this: “Mr Adviser, you knew that the NSS was coming and that at that stage I would most probably have to stop or cancel my RA - and yet you put me into a product where you knew there would be a penalty when you could have put me into one where there was none.”
I think that is inappropriate advice and would be interested to hear the industry or legislators take on this. I also think that RAs represent one of the biggest areas of conflict of interest in the industry (but this was not addressed by the legislation and is the source for another article).
So to answer the question, would I move RA at this stage?
I don’t think so; wait another year or two and see what comes out of the legislation.
Also speak to the insurer and see if there are other fund options available.
You may well find that there are some more than suitable funds (which are invested in underlying unit trusts), and you might be able to access these without incurring the hefty penalty for moving.