Sometimes the advice provided by financial advisers is based on "conventional wisdom". But it is often questionable whether such advice is accurate or appropriate.
The recent publication of codes of conduct for the financial services industry mean that simply dispensing conventional wisdom may no longer suffice. Financial product providers and intermediaries have to show that they have properly considered whether their advice is suited to your specific circumstances.
It is worth quoting from the General Code of Conduct for Authorised Financial Services Providers and Representatives, which was published last week by the Financial Services Board in terms of the Financial Advisory and Intermediary Services Act (FAIS).
The code states that a "provider must at all times render financial services honestly, fairly, with due skill, care and diligence, and in the interests of clients and the integrity of the financial services industry".
The code goes on to state that when financial services representations are made and information is provided to you, the representations and information must be:
- Factually correct;
- Provided in plain language, avoid uncertainty or confusion and not be misleading; and
- Adequate and appropriate in the circumstances of the particular financial service, taking into account the factually established or reasonably assumed level of knowledge of the client.
To me, this means that conventional - but often untested - wisdom can no longer be provided, particularly not on a one-size-fits-all basis.
In addition, I recently read a letter by a financial adviser - published in a trade magazine for intermediaries - which said that the financial services industry must help its intermediaries from falling foul of FAIS and its regulations.
It is in the area of conventional wisdom that financial services companies should definitely come to the aid of intermediaries.
Some years ago, financial services companies helped advisers and consumers enormously by introducing sophisticated computer programs that assisted us to carry out a financial needs analysis.
These programs have helped ensure that we make correct decisions about such things as setting and achieving financial goals, how much life assurance we need, how much we need to invest, and when and at what income we will be able to retire.
Now, financial services companies need to ensure that other areas of financial advice are appropriately covered.
Below are some examples of the conventional wisdom which are generally accepted as true but are not necessarily so. Instead, the value of following the conventional wisdom differs from person to person.
Conventional wisdom 1: Cash in your retirement annuity at 55
The argument for cashing in a retirement annuity (RA) at the age of 55 is that you should receive, as soon as possible, the R120 000 tax-free portion (or R4 500 for every year you belong to a retirement fund) of the one-third of the RA you can take as a lump sum.
The balance of the lump sum is taxed at your marginal rate of interest, while you invest the remaining two-thirds to draw an income which is taxed at your marginal rate of tax.
The argument for cashing in your RA at 55 is that the tax-free amount has not been adjusted for many years and will be eroded by inflation in the years to come.
But there are other factors to take into account. These include:
- The tax you must pay on the amount you must draw as a monthly pension. The life assurer pays tax of 18 percent on interest, foreign dividends and rental income made within the RA on your behalf. When you start to draw an income, or receive a monthly pension, after your RA has matured, that tax falls away and income tax becomes payable in your hands at your marginal rate.
Not cashing in the RA until you are, say, 60 defers the income tax, which means you are earning returns on money that would otherwise have been paid in tax.
- The costs of re-investing the money (both the lump sum and the monthly pension) until you take genuine retirement at, say, 60.
- Your average tax rate at 55 may be higher than it will be when you reach retirement.
Conventional wisdom 2: An RA is a great product because you defer tax
This advice may be appropriate for some people, but not necessarily for everyone. You need to consider your tax rate and the price of the RA that you plan to buy.
Conventional wisdom 3: Commute the full one-third of your retirement fund to a lump sum at retirement
This is not necessarily the best option. Although you should take the tax-free portion, it is debatable whether you should take the residue of the one-third, even though the balance of the lump sum is taxed at your preferential, average rate of taxation.
It may be better for you to only pay tax - albeit at your higher, marginal rate - as and when you draw the amount as an annuity (pension).
These calculations are different for everyone, because you need to factor in your tax rate, the benefits of deferring tax until you receive the actual pension payouts, the amount of your retirement savings, how long you reasonably expect to live, and the type of annuity you purchase.
Conventional wisdom 4: A unit trust is cheaper than an endowment policy
Again, your tax rate, the different ways in which unit trust funds and life assurance policies are taxed (both income tax and capital gains tax), the amount you invest, and the period for which you invest, are variables that affect which of the two products is better for you.
There are many more examples of where you should not simply accept conventional wisdom. Although the FAIS regulations only come into force next year, you should start insist now that your adviser does proper calculations for you.
Financial advisers who do not have the wherewithal to do the calculations should insist that financial services companies provide them with the computer spreadsheets that enable them to do the calculations properly.
As far as I can establish (and I am open to correction), no financial services company provides computer spreadsheets that enable the conventional wisdom to be challenged.
An aside
My compliments to Barbara Hogan, who chairs Parliament's finance portfolio committee, and the committee itself for holding a special hearing into the rackets that are taking place in the funeral assurance business (published in Personal Finance last week). The massive malpractice and fraud must be stopped, particularly because the poor are being exploited.
Legitimate funeral assurance companies, particularly those that are registered by the Life Offices' Association, have been voicing their concerns about the problems for a number years. It is time for action now.