by Magnus Heystek, Brenthurst Wealth
21 October 2020
It’s rather ironic that I started my career in financial journalism more than 35 years ago at The Star newspaper writing and warning about retirement annuities, that were all the rage at the time. This was in the days when the investment industry was dominated by the big three insurance companies — Sanlam, Old Mutual and Liberty Life — and they employed thousands of brokers selling these products to self-employed businesspeople and professionals.
Today’s article is to recommend that if you do have money in one or more of these products you should mature them immediately, provided you are older than 55.
With the help of some very attractive tax-benefits from Treasury these legions of advisors/brokers fanned out across industry ins each of the high-earners who were not members of the compulsory pension funds. They invariably were the doctors, lawyers, dentists and virtually anyone else who was self-employed.
At first glance these products were very attractive and were sold on the basis of “reducing tax”, which it did. Or rather, it delayed tax until a later stage.
But a little more digging into these products at the time revealed a much darker side which didn’t exactly feature in the marketing material. Remember, this was in the days before the internet and any search for the full breakdown of costs and fees involved making several phone calls in order to get hold of a hard copy of the rules of the product. I remember one insurance company refusing to give me a copy of the rules and I had to sit in a pokey little office in order to read it. Reason for this? They were afraid their “trade secrets” would fall into the wrong hands!
And this is where it got very interesting.
These RAs were all long-dated insurance contracts (the longer the contract the better) which (a) was very difficult to unravel and (b) involved several layers of costs all over the place.
The fact that RAs could only be accessed after the age of 55 made it such a wonderful product and, in my view, was the bread and butter of large life companies as once the money was paid across it had to remain there for 10, 20 and even 30 years. It was also very difficult to move your money from one service provider to another if you were unhappy with the returns and service. On such restrictions were large fortunes built.
And every increase in contributions — solicited in a feverish haste just before the end of the tax-year — was actually not an addition to an existing RA, but a new one, with a new full set of costs for marketing, commissions and other costs.
What made these products so appalling was that the upfront costs were determined by the size of the premium and the term. And this is where so many people/investors were lured into a financial trap that they could not get out of. There was an added incentive to the salesman to ensure the maximum term, up to 28 years, to ensure maximum commission. And also maximum profits for the insurance company concerned.
Each product/contract started off with a loan against the product which for the first number of years had to be paid off by continuing contributions. It would normally take between 5-7 years for any of these products to actually start accruing a positive balance.
And if you happened to break the contract after 55 there would still be the early-termination penalties, which still exists today.
So after writing a number of columns in the Money section of The Star I was called in for a “cup of coffee” by some PR from Liberty Life who wanted to have a chat. I obliged and with my best tie and jacket I traipsed off to Braamfontein, all in the spirit of good relationships, seeing that we were dealing with a major advertiser.
I was escorted towards a board-room and when the doors opened I was confronted with an army of actuaries, consultants, general managers all sitting on one side of this massive board-room table facing lonely little old me.
I suddenly realised that I had walked into a trap and that the whole objective of the exercise was to “educate” me about the merits of these long-dated RAs and what wonderful products they were.
I still wasn’t convinced and wrote so, incurring the eternal wrath of the life insurance industry. Years later — based on some exceptional reporting by the formidable Bruce Cameron — who succeeded me as editor of the Money section (then called Personal Finance) — the life insurance industry and Treasury, under the powerful gaze of then finance minister Trevor Manuel — agreed that these products had certain defects which culminated in an industry-wide mea-culpa and some R3 billion was added to these existing products as a form of compensation.
Today the terms and conditions of these insurance- based RAs have greatly improved, but I really wouldn’t know as I have never marketed them. But that did not remove the penalties for early termination, which still exists today.
More than 30 years ago I wrote that I didn’t like these products and found them thoroughly defective, almost criminal. I once tried to explain the workings of these products to an American investment consultant who was aghast at the SA authorities allowed such a product to be marketed. I much preferred unit-trust based RAs which were much cheaper and didn’t have all those massive penalties.
How Regulation 28 is choking your retirement
Fast forward to today. I have battled to find industry-wide numbers and have been sent from pillar to post to get the numbers, but the best guess I can come up with is that there must be close to R100bn invested in these products across the many life insurance companies in South Africa. Not only were most of these long-dated RAs penalised by the fee structure, but now — since 2011 — has the investment guidelines laid down by Regulation 28 of the Pensions Fund Act also added a further restraining factor on growth.
Prior to 2011 RAs could be invested 100% into offshore funds and these products, if kept going by investors, are worth gold. On the Liberty website I found an offshore RA-fund and the returns have been between averaging about 15% per annum over the last ten years or more. My recommendation to withdraw will not apply to those lucky ones who stuck to their offshore RAs.
RAs can only invest 30% of their total asset base in offshore assets. This used to be determined at fund level but is now at product level. Most investors today are only vaguely aware of the poor performance of the local market, but are shocked at just poorly the JSE has actually done relative to world markets over the past 10 years now.
Look at these numbers:
JSE against the world
Regulation 28 — which is shaped by the country’s economic policies and lack of foreign exchange — basically forces fund managers of your retirement fund to invest the bulk of your funds into a very poorly performing market. The investment industry tries very hard to downplay this as a contributing factor. But they would say that, wouldn’t they?
The other day I listened to a webinar from Allan Gray where the poor presenter resorted to using 100-year return numbers on the JSE to justify a 30% limitation on foreign exposure. Which is rubbish, by the way. Investment returns are determined by current economic cycles and not what might have happened decades and decades ago.
The JSE is increasingly resembling a backwater stock exchange and foreigners have been fleeing this market for the last 5 years and more in a massive way. Keith McClachlan, small-cap expert and fund manager, recently published an article on his website which suggested that all the foreign investments over the past 30 years has actually flown out of our market since 2015. Pretty heavy stuff.
The end-result has been that very few RAs (and preservation funds) have beaten the inflation rate over the past 5-7 years when total costs and fees are included. That goes for the country’s pension funds as well, by the way.
But while there is very little you can do as a contributing member of a pension fund (apart from requesting a total cash portfolio), you as a member (older than 55) can and should very strongly consider withdrawing your money from your RA and pension/provident fund immediately.
This, by the way applies to all RAs, and not only those from the life companies.
Once you hit 55 — even though you don’t intend retiring — should you consider withdrawing the one-third (cash-free up to R500,000 and thereafter taxed at a sliding scale) and re-invest the remaining two thirds into a low-cost living annuity with an investment platform that gives you 100% exposure to foreign funds).
The 2/3s has to be used to purchase an annuity, either a life annuity (which I don’t recommend at 55) or a living annuity, which I do.
By moving your retirement cash to such an option you can be invested 100% into the FAANG-funds for instance which last year have a return of 80% and more. Or a biotechnology, technology, health care and even gold fund if you happen to be a gold bull. It all depends on your tolerance to risk.
I personally matured two of my own RAs (which was sold to me many years before I became a finance reporter) and for years I saw the slow growth. It wasn’t a lot of money but I thought it could serve as a useful tool to test my recommendations. I combined two RAs (one from Sanlam and one from Old Mutual) into one on the Ninety one Platform (formerly Investec Asset Management).
The net average return since inception now is 20% per annum while last year the portfolio returned 52%. Compare this to the 2-4% per annum returns the traditional RAs have been given over the past 5 years and more.
The only small negative is that you need to make an income withdrawal, which ranges from 2,5% to 17,5% per annum, fully taxed.
Now and again I pick up some snide comments from other advisors and spokespeople from the investment industry about this advice, but I cannot find one good reason to stick to a plan that hasn’t produced real returns for over 5 years and soon to be 7 years.
The investment industry in SA — which is shrinking rapidly, by the way — is putting up a half-hearted front in defending the poor returns of the JSE, but privately tend to agree with my assessment.
Why would you not (a) get your tax-free portion out soonest (time value of money and all that), move the balance of your funds to a cheaper platform and get exposure to world-beating global funds with a costs structure more than 50% cheaper than where you currently are? And if the JSE starts out-performing again — commodity boom perhaps — you can always move your funds back to the JSE whenever it suits you.
So let me repeat: if you have any money in RAs and pension/provident preservation funds) you need to be seriously acting on this advice immediately. If your funds keep on under-performing going forward you only have yourself to blame.
Magnus Heystek is investment strategist at Brenthurst Wealth, SA’s Top Boutique Asset Manager for 2020.