The costs of retirement products have been very much in the news over the past year. But costs are not everything when it comes to choosing a retirement or any other financial product.
Let me illustrate my point by using Old Mutual's new range of Max products as an example.
A few weeks ago, I discussed the Max retirement annuity (RA) product in detail and compared it with the Old Mutual unit trust RA. In my view, the unit trust product is superior because it is cheaper, giving you a lot more money at retirement, and you can change your contributions without incurring the penalties that apply to the Max RA product.
The only advantage of the Max RA product over the unit trust RA is that it gives you a much wider choice of underlying investments, because the unit trust RA limits your choice to Old Mutual's unit trust funds. But history has proved that in many cases wide choice often results in bad choice. So, the restricted choice is not much of a disadvantage, particularly because Old Mutual unit trust funds have a good track record.
More recently, Old Mutual announced details of a Max range of annuity choices. Annuity products are investments you make with lump-sum payouts, particularly from retirement funds, including RA funds, to produce an ongoing income in retirement.
The Max "income" products are replacing a wide range of other pension choices offered under various Old Mutual life assurance brands. This will eventually leave the Max range of pension income (annuity) products and an Old Mutual unit trust annuity product.
For the purpose of this exercise to show you the factors you should take into account when buying an annuity (pension), I am also including Old Mutual's Galaxy product, which will be phased out.
Here are the important facts about each of the three products:
1. Unit trust
The distinguishing features to consider are:
- It offers an investment linked living annuity (Illa), with the underlying investment choices limited to Old Mutual's range of unit trust funds.
- You can switch between funds without incurring any charges.
- The minimum investment amount is R50 000.
- Commission paid to an intermediary is a maximum of 1.5 percent plus VAT (or 1.71 percent). No trail (annual) fees are payable. (You can avoid paying any commission by buying the product directly from Old Mutual.)
- The initial product cost is a maximum of 3.42 percent (including commission) of your capital.
- The annual costs are limited to the underlying asset management charges applied to the various unit trust funds.
- Old Mutual Unit Trusts does not have any systems to ensure you receive appropriate advice, apart from ensuring that advisers are licensed in terms of the Financial Advisory and Intermediary Services (FAIS) Act. This means you could be vulnerable to poor and inappropriate advice, particularly on investment decisions.
- The underlying funds do not pay any secret kickbacks (rebates) to Old Mutual's unit trust management company.
- You can transfer to a guaranteed annuity, but this will involve a new round of costs.
2. Galaxy
Galaxy is Old Mutual's linked investment services product company. The distinguishing features to consider are:
- It offers an Illa, and you can choose from a wide range of investments provided by Old Mutual and various other unit trust management companies.
- You pay 0.25 percent for switching between investments if the underlying unit trust fund charges this fee.
- The minimum investment amount is R50 000.
- The maximum upfront commission paid to an intermediary is 1.5 percent plus VAT (or 1.71 percent). The maximum trail fee is one percent plus VAT (or 1.14 percent) a year. Commissions and fees are negotiable.
Galaxy insists that you use an intermediary. Galaxy offers intermediaries various incentives, including luxury foreign trips, based mainly on sales. In my view, this is a perverse incentive for intermediaries to mis-sell.
- The initial product cost (including commission) is on a sliding scale, with 4.56 percent on the first R100 000, 2.85 percent for the next R400 000, 2.28 percent for the next R500 000, and 1.71 percent for all amounts of R2 million or more (assuming that no trail fee is paid to an intermediary).
- There is an ongoing product charge on the same sliding scale, starting at 0.86 percent and ending an 0.23 percent. (These charges exclude any annual commission.) The underlying investment choice costs are not included and will vary depending on the type of investment and the provider.
- Galaxy does not have systems to ensure you receive appropriate advice, apart from ensuring that advisers are licensed in terms of the FAIS Act. This means you could be vulnerable to poor and inappropriate advice, particularly on investment decisions.
- Galaxy collects kickbacks (rebates) from the underlying investment product providers, and it does not disclose these kickbacks or pass them on to you.
- You can transfer to a guaranteed annuity, but this will involve a new round of costs.
3. Max
The distinguishing features to consider are:
- It offers both Illas and guaranteed annuities (pensions).
- The range of guaranteed annuities is comprehensive and includes level annuities, fixed-percentage escalating annuities, inflation-linked escalating annuities and "with profit" annuities. The "with profit" annuity guarantees an annuity that increases annually, and the increase is guaranteed to be in line with the returns made on the portfolio.
- Most importantly, the Max product allows you to divide your money between an Illa and the range of guaranteed annuities. For example, you could have one-third of your money in an Illa, one-third in a level annuity and one-third in a "with profit" annuity.
- You can switch at no cost from an Illa to a guaranteed annuity. In the current low interest rate environment, it is often preferable to use an Illa initially, because the amount you receive from a guaranteed annuity is mainly governed by long-term interest rates. (The "with profit" guaranteed annuity is an exception.)
- You cannot switch from a guaranteed annuity to an Illa, and you cannot switch between guaranteed annuities.
- All options are in one product, paying you a single amount from any of the choices, each month.
- The product introduces an optional life assurance risk product against living too long rather than dying too soon. The policy will pay out additional sums at any age you specify after your 75th birthday, thereby topping up your pension. No additional or double commission is payable on this option, because the premium is deducted from your pension payment. Commission was based on the entire initial investment amount used to purchase the annuity.
- Max has a number of systems in place to help ensure you receive appropriate advice. These include:
* A computer-based analytical model that will: help you calculate the pension you require and can afford; do projections using different scenarios that take account of how long you may live and inflation; and steer you in the direction of the correct annuity product.
If you purchase a Max Illa, the model will assist you to select the most appropriate pension drawdown and select the correct underlying investments.
* All Old Mutual agents who sell the product must write and pass examinations on the Max annuity product range. In addition, Old Mutual's agents are being trained on most aspects of retirement, including the legal and tax rules to ensure they provide correct advice on all pension products, including the Galaxy and Unit Trust products. The same skill requirement does not apply to independent intermediaries who sell the Old Mutual products. They must only be FAIS-compliant.
* When it comes to selecting your underlying investments, Max applies the prudential investment guidelines required under Regulation 28 of the Pension Funds Act. Among other things, these guidelines limit your investments in equities to 75 percent of your total capital.
This is a good thing as many people with living annuities are facing destitution because they put all their money in high-risk equity investments (often on the advice of ill-trained intermediaries).
The distinguishing features of the Max Illa (branded as Max Investment Funded Income) are:
- The minimum investment amount is R500 000, unless you can show that this is not your only source of retirement income. Again, this is a good thing as it is not cost-effective to have an Illa below R500 000.
- Old Mutual has designed various risk-adjusted investment portfolios. The portfolios, which are managed by Old Mutual, are aimed at providing you with a sustainable income (pension) flow.
- The maximum upfront commission paid to an intermediary is 1.5 percent plus VAT. The maximum annual trail fee is one percent plus VAT. Commissions and fees are negotiable. Max insists you use an intermediary. Max pension business currently does not contribute to luxury foreign trip sales incentives. Hopefully, Old Mutual will keep it this way.
- There is no initial product cost.
- There is an ongoing product charge on a sliding scale, starting at 0.61 percent for the first R1 million, 0.56 percent for the next R1 million and 0.51 percent for any amount over R2 million. (These charges exclude any annual commission payment.) If you have more than one Illa, they will be combined for the purpose of calculating the costs, giving you the advantage of the amount discounts.
The underlying investment choice costs are excluded and will vary depending on the type of investment and the provider.
- Max collects kickbacks (rebates) from the providers of the underlying investment products and these kickbacks are partially passed on to you in the form of reduced annual product charges.
Look beyond the costs
Now look at the table Monthly pension payments from Old Mutual Illas. You will see that after all costs have been taken into account and assuming the same underlying investments, Old Mutual's unit trust living annuity will give you the best monthly pension. For lower investment amounts, Galaxy has very little to recommend it, but it becomes more competitive with large investment amounts.
The question you have to ask yourself is whether, in light of all the versatility and real options that are offered with the Max pension product range (both the Illa and guaranteed annuities), costs are the predominant issue. I think that for many people, costs may be less important than the versatility.
You need to consider all the options and decide what is best for you, and this also means looking at the offerings of other companies.
Maximum drawdown
Old Mutual has introduced a new maximum drawdown level of 12 percent for all its investment linked living annuities. The range required by the South African Revenue Service (SARS) is five percent to 20 percent. There are indications that SARS also intends to reduce the maximum level to 12 percent soon.
Defintions
Investment linked living annuity (Illa):
An annuity (paid as a monthly pension) based on a percentage (between five and 20 percent) of the underlying capital. The annuitant (pensioner) takes the risk that there will be sufficient capital to provide an adequate pension until death. On death, the pension can continue to be paid out to a dependant/s for life or as an accelerated annuity over five years. The annuity is not included in your estate for estate duty purposes.
Guaranteed annuity:
This is a pension that is guaranteed until you die. In most cases, your estate and beneficiaries receive no benefits when you die. The life assurance company takes the risk that it will meet your pension payments.
Guaranteed annuities are available in various structures, including level payments, escalating payments to keep in line with inflation, and as joint and survivorship, where the pension (or a proportion of it) will continue to be paid to a spouse after the death of the annuitant (pensioner).