WORDS ON WEALTH:
Apart from the obligations that contractual retirement annuities (RAs) impose on you to keep contributing for the full term of the contract, there is a further downside to these products: their costs. Personal Finance found that the costs on a contractual product may be about 2% more a year than on a flexible unit-trust RA.
Last week, Personal Finance covered the case of Mr C, who, at the age of 61 had been sold a Discovery Invest RA that committed him to a 10-year investment term with a 10%-a-year escalation on his R10 000 monthly contribution. Charles McAllister, a Certified Financial Planner and executive director of Centric Wealth Advisory in Cape Town, took up his case (see “A case against contractual retirement annuities”).
Discovery Invest offers a contractual product that provides the broker with a large upfront commission (the type Mr C was sold) and an “as-and-when” product (which Mr C was unaware of), which pays only a monthly commission to the broker.
The deal with the contractual product is that if you keep up contributions to the end of the term, a substantial portion of the annual administration fee (3.5% plus VAT in Mr C’s case), including returns on that portion, is refunded: a benefit called Fee PayBack.
However, even with Fee PayBack, the administration fee is considerably higher than that on a non-contractual unit-trust RA available from an asset management company.
To provide a comparison, McAllister obtained three quotes for a hypothetical John Smith: on Discovery Invest’s contractual RA, its as-and-when RA, and a unit-trust RA from a well-known asset manager. Mr Smith would turn 64 in January 2022, selecting to retire at age 75, and the product was to commence on April 1, 2021. Each quote contains an Effective Annual Cost (EAC) table, which details costs expressed as an annual percentage of assets under management over different periods and on expiry.
Quote 1: Discovery Invest Core Retirement Plan (upfront commission)
- Monthly contribution of R10 000, escalating at 10% a year.
- Invested entirely in the Discovery Balanced Fund (investment management fee: 2.13%).
- Adviser’s fee: R29 586 upfront lump sum plus R287.50 a month. According to the EAC table, this equates to 1.61% a year over the term of the policy.
- Administration fee: 2.42% a year, which reduces to 0.64% over the term of the policy after Fee PayBack.
- Overall EAC over whole term, after Fee PayBack: 4.38%
Quote 2: Discovery Invest Core Retirement Plan (as-and-when commission)
- Monthly contribution of R10 000, escalating at 10% a year.
- Invested entirely in the Discovery Balanced Fund (investment management fee: 2.13%).
- Adviser’s fee: 5.75% (including VAT) of the monthly contribution. According to the EAC table, this equates to 1.22% a year over the term of the policy.
- Administration fee: 0.64% a year
- Overall EAC over whole term: 3.99% a year
Quote 3: Asset Manager X Retirement Annuity (unit-trust RA)
- Monthly contribution of R10 000, escalating at 10% a year.
- Invested entirely in the asset manager’s balanced fund (investment management fee: 1.01%).
- Adviser’s fee: 3.45% (including VAT) of the monthly contribution plus 0.58% a year. According to the EAC table, this equates to 1.30% over 10 years.
- Administration fee: 0.24% a year
- Overall EAC over the whole term: 2.55% a year
McAllister says Quote 3 from the asset manager was not the cheapest available and, ”to compare apples with apples”, he asked for the maximum adviser fee on contributions. “This is generally not the norm, as most practices would charge an upfront planning fee once off, then an ongoing fee depending on their fee schedule,” he says.
Even so, the difference in costs between 4.38% a year and 2.55% a year is significant. Assuming a before-costs return of 10% a year, after 10 years, Mr Smith will have accrued R2 460 517 under Quote 1 and R2 685 089 under Quote 3, a difference of 9% (my calculations, assuming costs as a reduction of return, using thecalculatorsite.com).
Although costs should not be the only consideration when taking out an RA, the higher they are, the harder your money will have to work in order to beat inflation.
While the investment management fee depends on what underlying fund/s you choose and a provider’s administration fee is relatively fixed, the fee your adviser receives is negotiable under the Financial Advisory and Intermediary Services Act, enabling you to bring down costs further.
PERSONAL FINANCE