The term of a Retirement Annuity
The period (term retirement annuity) for which you sign up for a life assurance Retirement Annuity (RA) is one of the issues over which you must take great care. As a result of bad advice from often unscrupulous financial advisers and representatives of the life assurance industry, many people have, to their detriment, signed up for membership of retirement annuity funds for excessive terms.
The government has set two restrictions on the term for which you can belong to an RA fund. These are: · Earliest retirement date. You cannot draw on or surrender an RA until you are 55, unless you are disabled. In other words, 55 is your earliest retirement date. You can extend the period beyond 55, but you cannot access your money before you reach 55, unless you qualify for an ill-health pension. If you stop paying premiums, the money will remain invested until you are at least 55 years old. This is to ensure that your money is kept for retirement.· Maximum RA contribution period. You may not contribute to an RA past the age of 69. The government regards 69 as the latest age by which you should retire. This maximum is to prevent you deferring tax until you die, to the benefit of your heirs.
If you are a member of an employer-sponsored pension fund, you have to retire as a contributing member of your fund on the day that you retire from your job.
But, you can retire from an RA fund at any stage between the ages of 55 and 69, whether you are still working or not. In fact, from a tax point of view it is often worth delaying retirement from an RA as late as possible for a number of reasons, particularly if you belong to an employer-sponsored retirement fund. The reasons for delaying retirement from an RA include:· You can continue to claim your contributions to an RA against your taxable income until the age of 69;· You have the potential to increase the tax-free portion of your lump sum, although the amount will be quite small; and· Your marginal rate of taxation, and therefore your average rate of taxation, is often lower in retirement. This means that any amount you take as a lump sum, in excess of the tax-free amount, could be taxed at a lower rate than would have been the case if you retired simultaneously from your employer-sponsored fund and your RA. However, there must be an interval of two years between the two retirement dates for you to benefit from a lower average tax rate.
Unscrupulous advisers and life assurance companies have often deliberately misinterpreted the minimum and maximum contribution periods of an RA set by the South African Revenue Service (SARS).
The life companies claim they only encouraged people to take out long-term policies so that you did, in fact, save for retirement.
If you join an RA fund when you are, say, 20 years old, this does not mean that you have to commit to paying premiums until 55 or, even worse, until 69. You do have to remain a member of the fund until at least 55, but you do not have to be a contributing member of the fund for the longest possible term.
In most cases, you can limit your contractual premium payments to five years or pay a single-premium lump sum.
Tax law requirements do not dictate how much you should pay in premiums, how often you should pay premiums, or that you must pay premiums until age 55. The tax requirements only dictate that you may not withdraw money from an RA before the age of 55.
This does not imply that you should not save aggressively for retirement, making full use of all the available tax breaks. It does mean that you must protect yourself from the confiscatory penalties that life assurance companies apply if, through no fault of your own, you cannot continue to make contributions to your RA fund.
Commission
Many people were encouraged to take membership contracts of RAs underwritten by life companies up until the age of 55 or older because of the way that commission is paid to financial advisers selling RAs.
On a life assurance underwritten RA, advisers are normally paid commission based on the number of years of the contract multiplied by the premiums multiplied by three percent, with a maximum of 75 percent of the first year’s premium paid in the first year of the contract. In the second year, the adviser receives one-third of the commission paid in the first year. So, there is an obvious incentive to get you to sign up for the longest possible term.
You may not realize it, but you are affected by the way commission is calculated and paid to advisers by life assurance companies.
The life assurance company effectively gives you a "loan" to pay the commission and other costs associated with issuing an RA. Commission makes up at least half of this "loan", which life assurers often refer to as the "un-recouped costs". Part of your premium goes to pay off this loan. Interest is also charged on the loan. The interest rate varies between life assurance companies, but some life assurers charge close to the maximum permitted in terms of the Usury Act. The consequence of this is that less of your money is going towards your retirement savings.
If your financial circumstances change, and you decide to reduce your RA premiums or stop paying them altogether, the life assurance company will deduct this outstanding "loan" – or un-recouped costs – from the value of your investment. Life assurers often add on other costs – even future profits that they expected to make from your policy. The amount appears to be entirely at the discretion of the life companies. The "confiscatory" penalty may be even greater than your accumulated savings – this is particularly likely in the early years of your membership of an RA. The life assurance industry euphemistically calls the penalty a "benefit reduction".
You cannot foretell the future and neither can your financial adviser, the RA fund or the life assurance company issuing the RA. You may not be able to continue paying the premiums on an RA for any number of reasons, from losing your job to your business going bankrupt. Working women are particularly vulnerable as they often take time off to have children and cannot afford to continue paying their premiums.
RA premiums may also become unaffordable for people who change employers and become obliged to join the retirement fund sponsored by their new employer. Often they cannot afford to belong to both the employer-sponsored fund and an RA fund, and have no choice but to stop contributing to their RAs.
The advantage of unit trust RAs that are not under-written by a life assurance company is that, in most cases, commissions and other costs are only deducted as and when you pay the premiums. As a result, you can reduce or stop paying your contributions without incurring any penalties.
Avoid being stung by commission
There are a number of ways you can prevent yourself from becoming a victim of confiscatory penalties and perverse commission structures of RA funds sold by life assurance companies.· As a general rule, you should not sign a contract for more than 10 years, or beyond the age of 55. When the contract period is reached, you can always extend it for another five or 10 years.
However, you should establish the terms for extending a contract to ensure that additional costs are not loaded on to your policy.· Insist that commission is only paid as and when you pay your premiums, as is the case in the unit trust industry. There are RA products on the market that allow for this. They include:
* So-called new generation RA products. With these products, you are given the option to pay commission upfront or as and when you pay your premiums. But you must still be wary of these products because they can be costly, particularly if they offer you the choice of a wide range of underlying investments, which you may not really need, and if they add fees for investment performance. You should also be wary of products on which financial advisers are paid both commission on your premiums and a fee based on a percentage of your accumulated RA savings.
* Unit trust RAs. A number of unit trust management companies and linked investment services product companies (LISPs) provide RAs that have the same cost and commission structures as unit trust products that permit you to change your contributions without incurring penalties. Unit trust companies and LISPs sometimes "borrow" a life licence to avoid setting up their own funds, but they are entitled register an RA fund of their own.
LISPs are essentially investment administration companies that provide products, including RAs, that allow you to choose from a wide range of underlying investments from a number of different companies, mainly unit trust companies. LISPs normally pay part of the commission upfront, based on the contribution, and part as an annual fee, based on a percentage of your accumulated savings. Again, you must exercise care when dealing with LISPs. They have developed a poor reputation for protecting your interests and, apart from their often excessive commission/fee structures, provide sales people with perverse incentives to sell, such as luxury foreign trips.· Establish whether you are being issued with a "loan" on which costs and interest are being charged. If the interest rate is above what you would pay on a home loan, do not sign up for membership.· Establish the exact criteria, in writing, for any penalties that may be applied if you have to reduce or stop paying your premiums.
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