Retirement annuities (RAs) fall into two distinct categories and it is very important to understand the advantages and disadvantages before you invest and sign up for one or the other.
If you save for your retirement in any retirement annuity (RA), your savings are tied up until at least age 55.
Some RAs, however, have contractual terms that may tie up your savings for longer.
Once the two-pot retirement system is implemented you may have access to one third of your retirement savings made after the implementation date, but some older RAs with contractual terms will be exempt from this legislation.
Some RAs – typically those you buy from a life insurer - have contractual terms that you agree to when you sign the documents.
These RAs buy a life policy from the life insurer as the underlying investmen
t.
The terms of these life policies may cover:
These terms are, however, inflexible. You will break or alter the terms of the policy if you:
Breaking or altering the terms of the policy contract could incur a penalty – also known as an early termination charge or causal event charge – that can be levied on your investment.
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Life insurance RAs are underwritten. This means that when you apply for membership, the fund takes out a policy and the rules of the policy are also the rules of the fund. |
WHO SELLS THESE RAs
RAs with contractual terms are typically sold by life insurance companies and they may be offered with low minimum investment amounts.
RAs with contractual terms are often referred to as old-generation or traditional RAs.
FEATURES
RAs offered by life insurers can offer you features that are not available on more flexible RAs.
These include:
Life insurers can offer policyholders who agree to contractual terms investments in smoothed bonus portfolios.
In these portfolios the returns earned are smoothed because the life insurer holds some of the return back in times of strong financial market performance and allocates it to boost your returns when markets perform less well.
This makes the returns less volatile as your returns fluctuate less.
There is a cost to smoothing and if you are still a long way off retirement, you should try to understand fluctuations in returns from financial markets, the benefits of diversifying across markets and asset classes and then accept that the ups and downs will deliver good average returns over a long period of time. Read more: Why should I diversify my investments? and What do I need to know about investment risk and time?
Life insurers are able to offer policyholders who agree to contractual terms guarantees on the capital or on the returns.
These guarantees come at a cost and you need to decide if you really need them. Guarantees may be worth considering if you are close to retirement. If you will be saving over a longer period and have diversified your investments, they may not be necessary.
Newer policies with contractual terms offer loyalty bonuses for those who remain invested and contribute the agreed amounts. These bonuses can offset higher charges on these policies, but only if you can to stick to the terms of the contract.
COSTS AND PENALTIES
Costs on older policies are generally higher than those of new policies. Costs should be disclosed to you as an effective annual cost (EAC), making them comparable to the costs on another policy. Read more: How do I measure costs on my unit trust fund?
Over the term of the policy, the life insurer recoups the costs of the policy. If you change or alter the policy terms – by, for example, stopping your contributions, the insurer will recoup unrecovered costs by way of a penalty.
If an adviser is paid commission on the policy, this commission may be one of the costs that must be recouped. The commission they earn is based on the term of the contract. Part of the commission is paid upfront. If you break the terms of the contract, the commission paid is recouped from your savings by way of a penalty.
The Long Term Insurance Act requires life insurers to set out the formulae and rules for calculating policy values and the penalties that can be applied are subject to regulation under the Act. These regulations stipulate that:
Penalties depend on the premium payable, the commission paid to the adviser and when during the term of the contract you are withdrawing the proceeds.
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BUYER BEWARE You need to keep contributing to an RA for as long as possible to ensure you have sufficient income in retirement. Agreeing to contractual terms ensures you do keep saving for as long as the term of your contract and are not tempted to stop saving to have some extra money to spend. However, you need be careful about signing up for a contract that you may not be able to honour, if, for example, you lose your job, fall ill or face some other financial disaster. None of us can predict what may happen to us in the future.
Premium waivers that pay your contributions when you can’t may be a good safety measure but they come at an additional cost. |
Other RAs are flexible – you initially agree to contribute a lump sum or monthly amount – typically by signing a debit order, but you can stop and restart or reduce those contributions at any time.
WHO SELLS THESE RAs
Flexible RAs are typically offered by unit trust companies, exchange traded product providers or investment platforms.
You will often find these RAs referred to as new generation or unit trust-based RAs.
COSTS
Costs on flexible RAs are typically – but not necessarily – lower than those on contractual RAs.
There are no penalties on these flexible RAs.
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Contractual RA |
Flexible RA |
How long must I stay invested? |
As long as your contract stipulates or age 55, whichever is longer Typically, you will be contracted until age 55, but should the contract end before that age, you will have to stay invested until age 55 with some limited exceptions for ill-health or on emigration. |
Until age 55 There are some limited exceptions for ill-health, on emigration or if you have contributed only a small amount. |
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| Can I switch my RA to another provider if you are unhappy with it? | Not until your contract ends. If you switch before you may incur a penalty. | Yes |
How much must I contribute? |
As much as your contract stipulates | As much as you agree to contribute. The RA provider may only accept contributions above certain minimum investment amounts. |
Will my contributions escalate each year? |
Often the contract will include an annual escalation in contributions. It is a good idea to increase your contributions annually to ensure you save enough for retirement. |
If you agree to a debit order with an annual escalation, but you can stop the increase or reduce your contributions at any time. It is a good idea to increase your contributions annually to ensure you save enough for retirement. |
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Can I stop or reduce my contributions?
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The contract will typically state that if you do so you will incur a penalty for changing the terms of the contract. On newer policies you may lose a bonus instead of incurring a penalty but this may make your costs very high. |
Yes at any time and without cost |
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What penalties could be imposed?
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You may face penalties if you stop or reduce your contributions or switch to a new provider before the term of the contract is up. Penalties on policies taken out since 2009 can be as much as 15% of your policy, reducing to 0% over a period over shorter terms or half over longer terms. Penalties as high as 30% of the value of the investment can be imposed on policies taken out before 2009. |
None |
| Source: Smart About Money www.smartaboutmoney.co.za | ||
REMEMBER THE POLICY
If you agree to contractual terms, you need to be sure you can stick to the terms and continue to contribute or stay invested, or your financial disaster could be compounded by costly penalties.
UNDERSTANDING YOUR RA
