Fee for all: what to do about your costly RA
Retirement annuity fees could be eroding your precious savings
If you've heard the marketing for retirement annuities (RAs) that cost less than 1% a year and you're paying fees of about 3% on your RA, you may be - or should be - considering a switch. But what should you know before you take the leap?
Three percent doesn't sound like a lot, until you look at it in rand terms. On a lump-sum investment of R250,000 it's R7,500 in year one. On an investment of R1m, it's R30,000 in the first year, growing and compounding as your money grows.
The argument made by passive managers is that the impact of fees is the only thing you can be sure of when investing.
10X Investments says that someone paying 3% in fees rather than, say, 1% a year, receives almost 50% less money at retirement.
To use an example provided by the passive manager, a lump sum of R100,000 invested over a working life of 40 years and earning a return of 6.5% a year above inflation will grow to R1.24m in today's money. This is before fees. If you pay an annual fee of 3%, your lump sum will be only R396,000 after 40 years. But if you pay an annual fee of 1% of your investment value, your lump sum will be R851,000 at maturity.
According to 10X, most consumers are paying about 3% in fees on their actively managed RAs. 10X charges a maximum of 1.17% while Sygnia charges 0.76% - both of which exclude advice fees. (10X charges less for investments of more than R1m.)
An investor with an Allan Gray RA sent his quarterly statement to Money. Although his statement does not reflect the total fee, he's paying 3.25% a year. This is the effective annual cost (EAC), which is the standard way that financial services providers must now disclose costs to enable you to compare the impact of costs on returns.
The EAC comprises four components: an investment management fee, a platform fee, a financial advice fee and a discretionary investment manager fee.
The investor is paying an investment management fee of 1.12%; a platform fee of 0.58% to Allan Gray; a financial advice fee of 1.15% to his adviser and a discretionary investment manager fee of 0.40% to Portfoliometrix. The investment value of his RA is about R237,000.
The advice fee covers the cost of advice and you should decide the issue of what this advice is worth to you separately from the costs on your RA (see alongside).
Low-cost providers like 10X focus on the fees you pay when you buy an RA directly from it, without the help of a financial adviser.
If you are thinking about saving on fees, consider the following:
1. Redivert your contributions
First check if your RA is a "legacy" one that involved you contracting to contribute and stay invested for a term. If you stop contributing or transfer your RA before the term is up you will be charged a penalty, also called a "causal event" or "early termination" charge. This charge is typically a percentage of the fund value the life assurer charges to recover commission it paid upfront to the adviser who sold you the product.
If yours is a new-generation, unit trust-based RA, there will be no penalty for stopping contributions.
Knowing how much the penalty is relative to the fees you can save will help you decide what to do as you may have the option to switch the underlying investments without incurring a penalty, make the RA paid up but leave it invested to minimise the penalty, or switch the entire amount to a new RA by way of a section 14 (under the Pension Funds Act) transfer.
If you're a member of a well-governed, cost-efficient employer-sponsored retirement fund or umbrella fund that provides investment options suitable for you, you can make your RA paid up and make future contributions to that fund instead of your RA.
It may be wise to get some help determining what the costs are and what your choices are before you choose this route.
Also, check if your fund will allow you to make an extra contribution. Michael Prinsloo, the head of research and product development at Alexander Forbes, says there is no limit in law to the maximum amount that can be contributed to a company-sponsored fund, but there is a limit on how much can be claimed as a tax deduction.
He says most funds allow for additional voluntary contributions without limits, but you should check with your fund.
Before you stop contributing to a legacy RA, do a cost-benefit analysis to ensure that the lower fees will compensate you for any penalties you may incur.
The Allan Gray RA investor who contacted Money has a unit trust-based RA and is a member of an employer-sponsored pension fund. Fortunately for him, the fund offers employees a choice of portfolios, including a leading low-cost passively managed multi-asset fund.
If he were to make his RA paid up and choose to contribute to his employer-sponsored fund, he would pay a management fee of only 0.25% a year before VAT on the new contributions. He could also opt out of paying an advice fee on the paid-up RA, saving himself the 1.15% annual fee, but this would mean he would have to find another way of paying his adviser.
2. Switch underlying investments
If your RA is unit trust-based, find out from your RA provider or your adviser if you can switch the underlying investments within the RA to a passive fund.
Your financial adviser might not be willing to help you with this. He or she may be of the view that actively managed funds offer you a chance of beating the market.
Many independent financial advisers partner with discretionary investment managers, like Portfoliometrix, Miton Optimal or Morningstar, which have the expertise to put together portfolios to suit the needs of different types of investors.
If your adviser is willing to help with this switch, you could save up to 1% in fees to the discretionary manager and asset manager.
The investor with the Allan Gray RA, could, for example, switch to Nedgroup's Core Diversified Fund, one of three passive multi-asset funds on Allan Gray's platform. If the investor were to move out of the Portfoliometrix funds and into this fund, his EAC would drop to 1.02% before advice fees.
3. Switch to an RA with passively managed investments
You can consider switching RA providers by way of a section 14 transfer if switching your underlying investments fails to bring down your costs sufficiently, or your provider does not offer suitable underlying investments.
You can switch to an RA provider like 10X, ETFSA or Itransact where the underlying investments are all passive. Or you can switch to a provider like Sygnia, which offers a range of passively and actively managed underlying investments but charges no platform fee if you use Sygnia-managed funds.
Other providers, like Nedgroup, only offer their own funds in their RA and charge only the relevant investment fee on the fund.
If the Allan Gray investor were to switch his RA to one these RAs his EAC would drop as follows:
To a Nedgroup RA invested in the Nedgroup Core Diversified Fund: 0,72%;
To a Sygnia RA in the Sygnia Skeleton 70 Fund: 0,76%;
To the Itransact Moderate RA: 0,98%;
To the ETFSA Default RA: 1,04%; and
To the 10X RA: 1,17%.
(Some EACs reduce for higher investment amounts).
If you decide to switch your RA investments to passively managed ones, your adviser might not endorse your decision, and you could be shooting yourself in the foot if your RA fee is paying for good advice and potentially a higher return.