If built-in annual contribution increases are making your retirement annuity (RA) unaffordable, you may want to switch to a new-generation RA (see “Definitions”, below). You may also want to ditch your life assurance RA because high management fees are adversely affecting the returns. Or you may believe that the underlying investments for new RAs will deliver better returns over time.
But there’s a problem with switching out of a “legacy” RA: you may be hit with a vicious penalty that could destroy a significant portion of your savings.
A “legacy” product is a contractual savings product, such as an RA or endowment policy, sold by life assurers before 2009. These products could have high confiscatory penalties – also known as causal event or early termination charges – when you reduce or stop paying your contributions. Life assurers impose the charges to recover the commission they paid to financial advisers when the policy was taken out.
The penalty is typically a percentage of the fund value, and the percentage reduces over time.
There have been proposals to abolish upfront commissions, but an outright ban on early termination penalties on legacy policies is “unlikely”, Jonathan Dixon, the deputy executive for insurance at the Financial Services Board, says.
“We will probably be looking at a staggered phasing out of early termination penalties over the next few years. We are busy with work to assess the impact of phasing out early termination penalties on legacy products. It’s still too early to say what the impact would be.”
So, what can you do with a legacy product? You have four options:
* Keep the policy until it matures. This option may be particularly suitable if the life assurer will agree to stop or reduce the annual contribution escalations without imposing any charges.
* Make the policy paid up (stop paying the contributions). This could result in a penalty. If you then contribute to a new-generation RA, you need to establish whether, over the long term, the benefits of the new RA will outweigh the loss to your savings from the penalty.
* Transfer your savings to a new-generation RA offered by the same life company. Some life companies call this a conversion. When you transfer or convert, you might not have to pay a penalty. But if you later elect to do a section 14 transfer (see “Definitions”), you could be liable for a penalty.
* Transfer your savings to a new-generation RA offered by another product provider. This will require a section 14 transfer. You could be hit with a penalty, so you should first weigh up whether the fees you will save on the new product will outweigh the impact of the penalty.
Cost-benefit analysis
It is in your interest to transfer if the fees you will save on the new RA will make up for the capital you will lose (as a result of the penalty) over the remaining term of your existing RA, Pierre Puren, a financial adviser at PSG Wealth in Jeffreys Bay, says. For example, if the penalty is R5 000 and you have five years to go on your policy, the fees you save by moving the RA must exceed R5 000. If the new RA will cost you R500 a year less than the old one, you will save R2 500. It doesn’t make sense to pay R5 000 if you will save only R2 500.
Puren says your financial planner will be able to do the calculation, which should assume that the existing and the old policies will grow at the same rate, and take into account the fees of both RAs.
Three fees apply to new-generation RAs: fund manager fees, investment platform and administration fees, and advice fees (if a financial planner provides you with advice).
Puren says that, over and above “the obvious benefits of the lower fees”, there are other benefits to RAs on an investment platform.
“Probably the biggest of them would be the benefit of flexibility. There should be no penalty of any kind applied to your fund value. This would essentially mean that you could change, stop and resume your contributions as your needs dictate. It is also very easy to do additional single (or ad hoc) investments at any stage. You should also be able to switch the underlying funds at no extra cost.”
Consumers generally switch RAs from recurring-premium RAs into single-premium RAs, Philip du Preez, the chief executive of legacy solutions at MMI Holdings, says. Bear in mind that a single-premium policy could be cheaper than a recurring premium one, and this should not confuse your analysis.
You must ensure that the lower fees will compensate you for any penalties associated with the transfer, says Tiaan Fourie, a product development actuary for Sanlam, reiterating Puren’s comments.
Transferring out of a policy-based RA without first obtaining proper advice could cost you dearly in the long run, Fourie warns.
“Ultimately, the most appropriate RA for any individual depends on their unique needs and circumstances. There is no one-size-fits-all solution,” he says.
Choosing the right underlying investment fund(s) is crucial and outweighs the type of RA in which you are invested, Fourie says.
Key Factors
When you do a section 14 transfer, Fourie says you should understand that:
* You could incur a penalty;
* You will lose any life, disability or critical illness cover, and it may be more expensive to replace;
* You will lose any investment guarantees;
* You will lose a waiver-of-premium benefit (whereby you don’t have to pay your premiums for a certain period in the event of retrenchment or disability, for example);
* You may incur a fee charged by the intermediary who signed you up for the new RA; and
* Your new investment will have to comply with regulation 28 of the Pension Funds Act. Regulation 28 was amended in 2011, and individual policies issued before that date are exempt from complying with the asset allocation limits, whereas new policies must.
So if, for example, your old RA has an allocation of more than 75 percent to equities and you transfer to a new fund, you may have to reduce your exposure to equities.
Staying with your provider
Transferring to a new-generation RA with the same life insurer, as opposed to doing a section 14 transfer, may have one or more of the following advantages, Fourie says:
* In most instances, you will not incur a penalty when you transfer, but check with your financial institution, because practices differ;
* You may be able to retain your waiver-of-premium benefit;
* It is easier and quicker than a section 14 transfer, which can take up to 150 days to complete; and
* You will able to access the latest products, which may, in the case of a life assurer, come with features such as a loyalty bonus.
At this week’s Pension Lawyers Association conference, Dixon said a loyalty bonus is like a penalty in reverse, but it is more likely to be disclosed by financial advisers.
DEFINITIONS
New-generation retirement annuities (RAs): Unlike a legacy RA, a new-generation RA gives you the freedom to reduce, increase or stop paying your contributions without incurring a penalty. These RAs generally have lower fees than legacy RAs. The fees are paid as-and-when contributions are made, not upfront. New-generation RAs provide you with the choice of underlying unit trust funds.
Section 14 transfer: The transfer of retirement fund benefits from one retirement fund to another in terms of section 14 of the Pension Funds Act.
LEGACY PRODUCTS ‘HAVE VALUE’
“Legacy” retirement annuities (RAs) that have been retained for the full contractual term have performed well, according to life assurers.
In 2014, Sanlam published the findings of research it conducted on the performance of a sample of legacy RAs that matured in 2013. Sixty percent of these policies achieved a return of two percent above inflation, it says.
Just because a product is new-generation doesn’t mean it offers better value than an old product, Adrian Burke, the general manager at Old Mutual, says.
“If customers remain invested in their legacy product until maturity, there are no early disinvestment charges. They should seriously consider whether this is a better option than switching, particularly if they are close to the maturity date, say, within 10 years,” he says.
Where an investment value is reduced as a result of moving into a new RA, it’s not always possible to recover this loss over the term of a new policy, Burke says.
Mark Barberini, the divisional director of group enablement shared operations at Liberty, says the perception that legacy products are expensive needs to be checked carefully. “The new expense measure being introduced this year by the Association for Savings & Investment South Africa will allow a like-for-like comparison of the costs.”