Old-gen vs new-gen RAs, and why it matters
An old-generation retirement annuity fund (RA), which is policy based, is vastly different from a new-generation unit-trust based RA.
Abdallah Moosa, a planner and actuary at Cape Town-based wealth management company Fiscal Private Client Services, says RAs fall under the category of retirement funds (including pension and provident funds).
“They are essentially a ‘personal retirement fund’, and contributions are typically ad-hoc. The contributions are tax-deductible up to a prescribed limit. In addition, investment growth on fund assets within an RA are tax exempt.”
He says there are two broad types of RAs: policy-based RAs, which are underwritten by a life insurance company, and unit-trust based RAs, which are typically offered by an asset management company or investment service provider. “It is vital for investors to understand the differences between the two, regardless of whether a financial adviser is in the mix,” Moosa says.
What you need to know about an old-generation RA
- With a policy-based RA, you enter a long-term contract with the insurer, detailing the frequency and amounts that need to be invested over the policy term.
- A penalty is typically payable should you change the premium amount, or a termination fee is levied should you wish to stop any further payments.
- The minimum policy term is typically five years, which means that you need to be sure that they will be able to make all payments, along with agreed annual increases for the full term, before signing a contract. “This is a significant commitment for most people and should be considered carefully,” Moosa says. Typically, this RA has a built-in commission structure to remunerate the person selling the product. This adds to the cost of the RA along with other distribution-related expenses, such as marketing.
- These expenses are recovered from the RA investment over time and, for this reason, on termination or lapse of the policy, the provider typically recovers these expenses using the termination penalty.
Moosa says: “Many old-generation RA products incorporate a loyalty bonus structure, which is added to the benefit payable when the investment matures. This incentivises you to continue contributing until the end of the policy term. Some providers will withdraw the bonus should you decrease or stop making payments. This, along with the termination penalty, acts as a disincentive for stopping prematurely.”
An examination of the product literature and fee structures for a number of insurers have shown that investors may be funding their own “bonuses” through higher fees, which are typically shown under the “Other” line item of the effective annual cost (EAC) table. An EAC report details all the fees and costs throughout the investment term and can be requested from any provider.
There are some insurers whose bonuses give investors back much more value, leading to negative fees in the EAC table. These clients would end up paying less fees, leaving them with more investment growth. This is typically achieved where the insurer uses a shared-value model, through a rewards programme for members.
What you need to know about a new-generation RA
- New-generation unit-trust based policies are a lot more flexible, cost-efficient, and straightforward.
- There are no contracts or any commitments.
- You can make once-off or regular investments, as long as the amounts meet the provider’s minimum investment requirements.
- Contributions can be amended, paused, or stopped at any time. This is especially important if your circumstances change, such as being retrenched. All fees, charges or commissions are typically paid on an as-and-when basis only, meaning there are no termination or other penalties.
- You can also switch providers at any time without any penalties.
“An examination of the EAC tables for a number of new-generation RA providers show them to be far cheaper than policy-based RAs. These providers tend to operate with very low administration costs, and therefore the bulk of the on-going cost will typically come from investment manager costs,” says Moosa.
In conclusion, he says: “Since your RA will typically have a long investment term, especially if you start contributing at a young age, it’s important to have a good understanding of your ongoing costs. It is also vital to understand how and who will be managing the underlying investments, as ultimately this will impact how much money you will eventually have at retirement.”
This article appears in the March 2021 edition of the free digital IOL MONEY magazine.