Retirement / 6 February 2019, 11:30am / Steven Nathan
MOVING into retirement is daunting for most people, even those who seem to be well funded. There is an instinctive fear of consuming capital and running out of money one day. Retirees, therefore, tend to be on constant lookout for ways to cut back on their expenses.
Few of them realise, though, that the cost of their living annuity is likely to be their single biggest expense in retirement, and that switching to a low-cost provider could greatly improve their financial position without detracting one bit from their lifestyle.
According to National Treasury statistics, as many as 80% of retirees choose to put their pension savings into a living annuity, rather than a guaranteed annuity simply because it leaves them in control of their money. They decide how much income they draw every year (within regulatory limits), how their money is invested, and who inherits the balance after they die. A guaranteed annuity does not come with any such options.
There is another important control aspect that tends to be overlooked: as a living annuity holder you can also change your service provider. You can move your living annuity from one company to another without restriction or penalty in most cases. Again, this is not possible with a guaranteed annuity. With a guaranteed annuity, once you have paid over your money to the insurance company you are stuck with them for life.
Given that you’re already in control of your investments and your income the ability to move your savings may seem redundant. But there is one aspect you have little say over: the fees that your current service provider charges. So if you are paying excessive fees (more than 1% pa in total), being able to switch to a lower cost provider is a very valuable benefit.
Few living annuity holders, and indeed few advisors, appreciate that their savings are depleted not only by drawdown rates but also by fees. If you are drawing down at, say, 5% pa, and paying fees of 2,5% pa (plus VAT) then you are effectively drawing down at almost 8% per year (fees of 2,5% pa is the Government’s estimate of the industry average, typically made up of 0.75% for advice, 0.25% for administration and 1.5% for investment management).
If you can afford to draw down at 8% pa, incurring 2% pa less in fees simply means that you can pay those fee savings to yourself. In other words, you could draw down at 7% pa instead of 5% (translating into an instant 40 percent pay rise!) without accelerating the depletion of your savings.
To illustrate, assuming you draw down 5% from your R4,8 million pension pot, you will receive a pre-tax income of R240,000, or R20,000 per month. At the industry’s average fee rate of almost 3% pa you would also be paying costs of around R144,000 pa (R12,000 pm). In this scenario, you are paying yourself only two-thirds more than you are paying your service providers. Or, from another perspective, almost 40% of your total drawdown goes towards fees!
Moving to a low-cost provider, such as 10X Investments, which charges less than 1% pa in fees, you could instead draw R28,000 a month, and pay fees of only R4,000 pm. You are now receiving seven times more than your service providers, which seems a far more equitable split.
But drawing down at 8% per annum will deplete your savings quite quickly. Depending on your choice of portfolio, you risk a drop in lifestyle within 9 to 11 years. That is the time when you are likely to hit the regulatory drawdown limit of 17,5% pa, and your annual income may no longer keep pace with inflation. Eleven years is way too early for this to happen if you retire at age 60 or 65, with a statistical life expectancy of another 15 or 20 years.
The more prudent option in the above scenario would be to keep your income unchanged, and let the 2% pa cost savings compound within your living annuity. This can add between 5 and 15 years to the sustainability of your income (again, depending on your choice of portfolio and future market returns).
It is a fairly simple process to move your living annuity. It requires that you submit an application to your prospective annuity provider and give formal notice to the incumbent. The rest happens behind the scenes. If you are joining a low-cost provider there should be no initial fee and no compulsory advice fees or platform fees.
There are other good reasons besides costs to switch providers, such as bad service, poor planning tools, or inappropriate investment choices.
Note, however, that you will not be able to bypass regulatory drawdown limits by switching. Your original policy anniversary date will follow you to your new provider, and your annuity income and payment frequency will remain the same until the next policy anniversary date, when you can make changes. You will also not be allowed to split your living annuity between two or more providers.
While there is little you can do to increase your retirement pot once you have stopped working, there are ways to get more out of your savings, especially by keeping your living annuity fees low.
Steven Nathan is the founder and chief executive officer of 10X Investments. The views expressed here are his.