Last week an article by Darren West of Foord Asset Management set the cat among the pigeons when he argued that a unit trust could be a better form of retirement savings than a retirement annuity.
His argument is that a retirement annuity requires the investor to hold a maximum of 75% of equities (shares). Over time equities should outperform other asset classes like cash and bonds; therefore, investors in retirement annuities risk underperformance.
It is an interesting argument but it has some flaws and it is not time to throw RAs out of the window.
Do equities outperform?
According to 20-year figures, property was the best performing asset and bonds produced the same returns as equities (15,22% a year).
So there goes the argument that a pure equity fund would have outperformed other assets. This highlights the fact that asset diversification does not necessarily equal lower returns. The structural change in our inflation rate in the past 20 years did favour bonds and property and it is unlikely that we will see similar returns again, but no one has a crystal ball. And even in a strong equities environment such as the one we had in the past 10 years, a fund like the Investec Opportunities Fund, which is limited to a maximum of 75% in equities, has outperformed the JSE All Share Index.
Being able to protect money during a market correction can have a very positive impact on long-term returns.
The feel-good factor
Sunel Veldtman of BJM Private Client Services argues that although the risk of equities is minimised over time, people do not like to experience losses in the short term.
She says if someone sees their retirement nest egg falling by 50%, they may be more inclined to stop saving. Veldtman says the BJM managed fund, which is used for retirement funds, did not have one negative year during the financial crisis. This gave investors a great deal of confidence in their retirement future.
Additional savings
One should never invest only in an RA. You need to be saving in investments that allow you more flexibility so that you can better structure your needs around retirement. Two-thirds of your RA has to be invested in an annuity, so you need additional funds to provide a lump sum at retirement. These savings could be fully invested in equities if the rest of your retirement funds are not.
Savings paid by the taxman
Although West says his argument takes the tax benefit into account, there would have to be some serious outperformance by equities to offset what is a significant saving. Some studies show that people with a tax rate of 40% could double the amount available on retirement if they saved through a retirement annuity. It is not only that you invest with before-tax money, but all capital gains and interest are exempt from tax.
Locked away
While one of the criticisms of RAs is that you cannot access them, that is also why they are good retirement vehicles – they provide you with the discipline not to touch your retirement nest egg.
It is just too easy to lay our hands on our other savings when we feel the financial pinch.
Just save
We spend so much time worrying about which is the right investment that we land up not saving.
While selecting a good investment vehicle is important, it is not as important as starting to save. A client of Sunel Veldtman of BJM Private Client Services started a retirement annuity with Old Mutual 10 years ago – not exactly a fund that shot the lights out, and it had the old cost structures, yet it has delivered 14% a year over the past 10 years. That is a good return and without it her retirement funding would be significantly worse off.
Understanding and managing investment costs
Darren West of Foord Asset Management doesn’t talk specifically about costs, but costs and the inflexibility of retirement annuities have been a major problem.
New-age retirement annuities: Fortunately, there are new products that are cost-effective and flexible. Financial coach Gregg Sneddon is a big fan of unit trust retirement annuities like Coronation, Allan Gray, Investec and Prudential.
Many of these do not have upfront administration costs or even ongoing administration fees. You still pay to invest in the underlying unit trusts, but it is no more expensive than unit trusts.
That said, you do need to watch which underlying unit trust funds you select. Most of them have annual fees of about 1,5%, but those with performance fees can have total expense ratios as high as 2,5%.
The cost of choice: The reason these unit trust companies can charge so little is because you are only investing in their funds. The costs come when you want a wider choice. Sunel Veldtman of BJM Private Client Services says the past 10 years have been marked by a major increase in choice for investors, but this has come at immense cost.
For example, if you choose a platform that allows you to invest in a range of different fund managers it is going to cost you around an extra 1% a year for choice.
In just 10 years, that choice will cost you R20 000 on a R2 000-per-month retirement annuity.
If you are invested through a multi-manager fund or fund of funds, Anne Cabot-Alletzhauser of Advantage Asset Management has calculated that the benefit of manager diversification is diminished once you are paying more than 0,5% per annum for fund selection.
Cost of advice: Adviser fees are negotiable. You can invest directly if you are comfortable not to receive advice.
If you do use an adviser, decide how much you feel is a fair fee. They can charge up to 3% upfront and 1% annually. If, for example, you were investing R2 000 a month, the most the broker would take would be R60 per month or R720 a year.
In addition, the ongoing annual fee after five years would earn the adviser around R1 500. So discuss this openly with your adviser. If he or she are going to meet you for an hour or two once a year, you need to decide how much it is worth.