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I’m 22 – how do I choose a low-cost annuity?

Retirement annuities: the difference between those offered by life insurance companies and LISP platforms.

I am 22 years old and would like to start [investing] with a low-cost annuity. I just started working last year so I can contribute about R1 250 per month to a fund (increasing 10% per year or more depending on professional qualifications gained, experience, promotions etc.). I have set aside R25 000 just to give my chosen investment a bit of a head start.

The question is as follows: what fund or company should I rely on? My financial advisor proposed starting with the Sanlam Cumulus Echo Retirement Annuity and this plan has fees of 4% upwards. 

What about 10X and Sygnia, which have much lower fees than the rest? Do I make a decision like an old realistic man and choose a retirement plan from well-known companies like Allan Gray, Sanlam etc.? Besides the fact that high fees take a huge bite of your growth, I am concerned about the longevity of such an entity. Will it still be around in 35 to 40 years?

Janet Hugo - Sterling Private Clients (Pty) Ltd

  

I really appreciate the sense of urgency of this young person to think about and do something about their retirement planning. Well done. To get the best compounding leverage, the sooner you start with a retirement plan, the better. There are several calculations to prove this,  but I think your questions around fees and which company to use are also important.

There are two types of retirement annuities offered in South Africa. Those offered by a life insurance company like Sanlam, Discovery, Liberty etc. or those offered by a linked investment service provider (LISP) platform like Allan Gray, 10X, Glacier and others. South Africa has a robust financial services sector and as long as you or your advisor do your homework to choose an investment offered by a substantial institution, I feel confident that the longevity of the companies you choose to invest with are not the biggest problem you face. I am assuming you will be alert to any changing risk environment after investing as well.

Life company products (like the proposed Sanlam Cumulus Echo Retirement Annuity) tend to be somewhat rigid. In essence you would enter a contract with the life company to pay your premiums plus increases for a certain number of years and you will remain invested until age 55 or later. It is likely that if you invest in a life company product you are agreeing to pay your financial advisor in advance for all those years of service still to come, assuming the advisor provides ongoing advice and support the way he should. 

Another issue is that should you make any changes to this contract, the life company is within its rights to apply expensive penalties to your saved capital, which would reduce real returns. I’m really not in favour of paying for financial advice in this way. 

While you probably have every intention of contributing to these retirement savings on an ongoing basis and increasing your contributions over time, you need to remember that life is often full of surprises. 

Let’s have a look at some potential curve balls: assume a new employer insists you become a member of the company pension fund and your total contributions of your salary are now more than the legislated 27% maximum. Or you could be offered a job outside of South Africa for a while. Either of these happy scenarios would lead to you needing to make changes to your contribution or your planned increases of 10% per annum. The life company would be entitled to apply expensive penalties.

You have correctly pointed out that fees tend to be higher in these types of retirement vehicles. So you need to compare the  effective annual cost (EAC) across the proposed investments. The EAC also enables us to value and account for so-called bonuses offered by some companies, as well as  all other costs, right down to stockbroking costs within the unit trusts. Pay attention to the EAC both in the short and long term. 

When you compare the fees of unit trusts, make sure you compare the total investment costs (TICs). The TICs will include transaction costs and the total expense ratio (TER), which includes any performance fees. 

It’s often surprising what the real total cost is, compared with marketing material that may only emphasise the competitive portion of the total cost.  

An analysis of the EAC that we did across eight different companies showed that life companies struggle to match the costs offered by a LISP platform. For investors to reap the rewards of the bonuses offered, usually takes many, many years. Calculating the real costs is vital, because compounding high costs hurts returns and while you wait for bonus rewards, your life and your needs can change. You need to assess whether waiting out long contract periods is realistic.   

What am I suggesting? At Sterling Wealth we believe in keeping investments appropriate for your needs and as simple as possible. After all, what is it you need? Capital growth at reasonable risk, with some flexibility. We believe that most investors would probably be better off using a flexible LISP platform that gives more investment choices, as opposed to a platform offering only index trackers. The LISP platforms will not penalise you should you stop your contributions or make other adjustments. Well-known companies like Allan Gray and Glacier offer investors a large range of active unit trust strategies and fund managers to choose from, as well as various index trackers.  

Your EAC calculations may show that it might be slightly more expensive to use a LISP platform in the beginning than going directly to an index tracker platform like 10X or Sygnia, however, longer term, the additional investment flexibility may deliver a profit edge. Also remember that while index trackers have their place, so-called passive investing in trackers is a cyclical strategy and will not always outperform as well as they have in recent years of soft interest rates and quantitative easing. 

A good advisor helps you understand what you are investing in and the potential value of bonuses and increasing contributions over various time scenarios.

  

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Stay away from life insurance companies and ongoing fees!
Source an independent advisor (with cradentials and a license) and adjust your financial goals as the circumstances in your life change.
Use other people’s advice only as a guide and have a portfolio for your own personal needs/goals.

Do not, i repeat, do not use any life insurance company

Also, do not committ to any monthly contribution because when ‘life’ happens and you unable to pay your compulsory monthly premium, heavy penalties will be incurred. They will have no problem enforcing the terms of the contract despite any pleas

Set up a monthly debit order for any payments you want done. I’m lucky that my monthly contribution (maximized to 27.5%) has immediate tax advantage and my monthly tax paid is substantially less. If your employer has a pension fund, chat to your HR dept as their costs are usally much lower and the possibility of immediate tax relief is very sweet

Listen to OCNARF.

Yeah, I’m with Old Mutual and can’t say I’m happy with the growth rate of my RA, especially when inflation is taken into account.

Seeing my advisor in about 2/3 weeks time, think we’ll need to have a little chat.

In my opinion, stay away from any life insurer (for example, the Sanlam one, the bonus is just a penalty in a clever disguise, you are paying your own bonus with those fees, and if you make causal changes you lose part or all of that bonus)

What I’d do:
Choose from the likes of Coronations, 10X, Sygnia, Alan Gray or similar, whichever one I think is best after reading their fact sheets and marketing material. Choose the Balanced Fund from that provider (then there is normally no platform fee, one just pays the internal fund fees as per TER/TIC on fact sheet).

Those providers make it so easy, one does not need a Financial Advisor. One just fills in a few pages of a form, provide proof of residence and bank and off ones goes and the debit order runs once a month. I only use a FA for life insurance and similar.

Save at least 20% of income in the RA, anywhere up to 27.5% (thats if you do not have a work fund, then just use RA to top up retirement savings). The more one saves now, the less pressure one has to save later in ones life, say when you are in your 50s.

I only started gainful employment at age 29, I so wish I had been able to start earlier, like at your age.

And remember to do e-filing one you get an RA. You will get back some of your contributions from SARS, if you paid income tax that is.

And don’t worry too much of the investment company ceasing to exist. The investments are not held in their name. The money is protected from most types of creditors as well.

I did the same with the online investing (Allan Gray/Coronation etc). You save on advisor fees and their applications are so simple and easy.You can change your portfolio as you please, whenever you want. They also provide graphs for your performance against inflation.Check them out.

Don’t bother with Life Assurers.. you will lose most of the growth in platform & other costs. I suggest going direct to a linked investment service provider (LISP) as mentioned above and investing via that.

2ndly you have a choice between active and passive investment. Active costs more and aims to ‘beat’ the benchmark which is what the passive essentially achieves. Since he is very young decide on a ratio between the two and let it grow from there.

SA is a bit unique in that passive investing doesn’t consistently outperform active investing.. but that may change in future as it has in the US hence I do mix of the two. Just make sure to evaluate your fact sheets accordingly and file for the tax rebates with sars or get company to submit as paye process.

Excellent advice so far. My only addition would be to never sign a debit order, instead pay by monthly payments at your discretion. You never know when you may fall on hard times when the amount to be paid nay be hard to get, and if that happens then the payments are still under your control.

4% in fees??!! Run for the hills, and find another financial advisor!

Anything over 1% I wouldn’t even consider. Watch those fees, they compound over time, eroding your wealth!

Sage advice from all the other comments.
My only other advice is not to put all your retirement savings into Reg 28 funds. Have some discretionary retirement savings. A tax free savings account is a good place for that!

2 Things they sell you out the gate– Life Cover and a Retirement annuity. COMMISSION, COMMISSION, COMMISSION!! There is a very good chance that your employer will have these benefits in his company. Remember you will be getting married, having kids and living a normal life. Don’t tie up your assets so you can’t touch them for 33 years (if they will even be there???) The first 5 years of as home bond are ALL INTEREST!! So will you be paying HUGE interest whilst making a pittance on your R.A.? TAX BENEFIT– Many people believe the tax benefit is why. SO YOU WILL GET A TAX BENEFIT AT THE EXPENSE OF PAYING HUGE INTEREST! You Lose! Home bonds 9%-10% RA returns last year 4%-5% generally. Ask people if they feel like they are not getting ahead in life? I just showed you 2 BIG principles!!

FinFit, I normally admire your passion for advocating a debt free life. So, not to take away from your message, 2 points.
1 – The first 5 years is not ALL Interest. You pay principle from day 1. Maybe not a lot, but you do. So your comment is inaccurate. It is true that you MOSTLY pay interest in the first 5 years
2 – Life insurance to cover your mortgage is the responsible thing to do for your family. Yes obtain this as transparently and with as low a fee / best rate as possible, but you should not skimp on this. Unless you do not have a family and your estate can deal with settling the bond.

Your job should offer you benefits TAKE THEM. If 95% of South Africans will not have enough money @ retirement what’s your choice??? They continue to say “Find a qualified financial advisor.” You are in the 95%. Don’t tie up your money for 33 years. You will have a home bond and children with school fees. Get debt free 1st!!

Paying 4% in fees vs less than 1% will have a staggering impact on your final retirement pot…Going directly to the provider of your choice will help keep fees down as well.

S&P do a great job of tracking how many active managers under perform the index in SA – the stat, over a 5 year period, after fees, at the moment is 83.72% (https://us.spindices.com/spiva/#/reports), which is why picking an index fund, within a reg28 framework, is so strong over a long time period.

If you want to see the impact fees have on an annual basis, feel free to use the thinkdirect fee calculator (https://goo.gl/4JLhdD).

Solid advice from Janet.

Remember that some life insurance companies can offer RA’s under their Life license as well as under their LISP license. I’m a fan of LISP platforms.

Do consider a TFSA consisting of low TER ETFs

Yup agree with this route and at least charges are low and you keep control of your own portfolio

Hey Janet, Its easy. 1st, dont go anywhere near the insurance companies. 2nd, Start saving and plan to buy yourself a house.

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