ecsponewsInvesting with the times

Newsletter ▪ April 2018

Ecsponent is a FPI Corporate PartnerTM

Is it time for an annuity?Fewer people are buying retirement annuities (RAs) and this trend has caught the investment industry off guard. Especially since it was once one of the most popular savings instruments.

Moreover, there is a sharp increase in people redeeming their RAs, which could indicate that more people are starting to look at other investment products for retirement.

Last month the Association for Savings and Investment South Africa (Asisa) issued statistics, which showed that sales of single premium RAs last year were 6% lower than the previous year, while recurring premium RAs decreased by 17%.

Sales of compulsory annuities also decreased by 32% over the same period. This extraordinary large figure can also be attributed to the amendment of the de minimus rule. The amendment increased the minimum lump sum withdrawal from a pension fund in March 2016 from R75 000 to R247 500.

Pitfalls with annuitiesRAs are one of the most disciplined savings instruments for creating and securing a retirement nest egg, but they come with strict rules. Before investing, you need to be sure than an RA is suited to your overall investment strategy.

The older generation RAs are especially notorious for deducting high costs and commissions. Additionally, you may face liquidity problems as you can only access your RA at age 55, when you can withdraw one third in cash. You may not use the RA as guarantee/security and there are limitations to where and how much you may invest.

There are also benefitsAn RA forces disciplined savings. It is ideal for people who lack the self-discipline to save for their old age without dipping into their funds along the way.

Your RA falls outside your estate and after death your beneficiaries will receive cash directly, under guidance of the trustees. This means estate duty is not payable on the value of your RA. An important benefit of an RA is that you can deduct 27.5% of your salary or income (up to a maximum of R350 000) when contributing to an RA, which reduces your taxable income and lowers your tax liability. In this way SARS pays a part of your retirement cost.

RA advocates also point out that investment growth in the RA is tax-free. You do not pay capital gains tax, dividend withholding tax or tax on interest. However, bear in mind that you could be deferring your tax liability because, at retirement, the income from your RA will be taxed at your marginal rate.

When you retire from a fund, two-thirds of the retirement annuity must be used to purchase an annuity, which will pay you an income in retirement. There are two well-known types of annuities:

Guarantees with a life annuityFirstly, there is a policy-linked or guaranteed annuity (life annuity), issued by an insurer. It pays a lifetime guaranteed pension amount, regardless of market developments. The insurer therefore takes investment decisions and risks. You do not have to fear that your money will run out in your lifetime.

However, the disadvantage is that you cannot change your mind and will be liable for penalties if you redeem it before the end of the term. Early redemption is seen as breach of contract. The penalty can result in the policy value, as in a recent case, reduce from R342 000 to R284 000, a loss of R58 000! The insurer carries the risk and this means you sacrifice by earning less income. Upon your death, the insurer retains the balance of the capital. You cannot bequeath money to your heirs, unless you choose a specific term or pursue a surviving spouse option.

Market risk is part of a living annuityThe second type is an investment-linked annuity (living annuity also known as illas). This type allows you to stop contributions at any time without penalty. There is no guarantee of return. You control your investments yourself and take a calculated risk according to your own profile and income needs. Funds remaining after your death can be paid to your heirs.

The downside is that it does not guarantee a regular income. The investor must select the underlying investments and thus bears the risk of fund performance and capital protection. If markets perform poorly, or if you withdraw too much income, you run the risk of running out of funds before you die.

The responsibility and market risk rest on your shoulders, not on the investment company.

The dilemma is exacerbated if the investor withdraws too much income. An investor may withdraw a regular income of between 2.5% and 17.5% of the asset value per year. However, if you withdraw more than 5% per annum, you run the risk of depleting your capital prematurely.

RAs may or may not be the best retirement solution for everyone or in all situations. However, used as part of a considered investment plan, it offers several benefits. It is best to discuss your needs with a financial advisor to determine how you can reach your investment goals.

South Africa: info@ecsponent.com • 087 8080 100 Fintech Campus, Corner of Botterklapper & Ilanga Streets, The Willows, Pretoria, GautengSwaziland: swaziland@ecsponent.com • +268 2417 1616 • 7 The Gables, Ezulwini, SwazilandBotswana: botswana@ecsponent.com • +267 391 8756 • Sixth Floor, Exponential Building, Plot 54351, New CBD, GaboroneAll content is for information purposes and should not be regarded as investment advice. ecsponent.com

Simplicity is king The more complex and structured your investment product is, the more likely it is to attract additional costs, leading to poorer returns.

Therefore, your investments should be in simple and transparent products. Before you invest in an exotic structure, stop to ask yourself if you truly understand it. The old adage about time value applies here: those who understand it earn it... and those who do not understand it, pay for it.

Understand your investmentIf an option is explained to you and you do not grasp it within ten minutes, you should rather avoid it. Simpler and more transparent investments are more likely to offer ongoing healthy returns. A good understanding will help to reduce unnecessary losses to costs, or as result of theft and fraud. It will also lead to more realistic expectations about returns. Complex, less transparent products might camouflage high risk and high costs between all the structures and fine print. Sticking to simple investments was key to making Berkshire Hathaway one of the most successful companies in the world. Charlie Munger, Warren Buffett’s partner at this company, noted: “Investors do not support our model, because it appears to be too simple. Most people do not believe one could be an expert when it is that simple.” The Benchmark Survey -- a comprehensive study of the South African retirement industry -- found pensioners often did not understand their investment products. A large percentage thought, for example, they had bought guaranteed annuities, while in fact they had invested in living annuities. Likewise, too many people choose the wrong options, because they cannot distinguish between the different options.

Another example is the confusion between a money market fund (which may include some banks’ money markets) and a money market investment at a bank. These investments are also often confused with an income fund which has a much higher risk.

It costs you moneyInvestors often follow advice with regard to different platforms, intricate investment and derivative instruments like CFDs and SSFs, which provide minimal returns after very liberal costs are deducted. These extravagant costs and fees diminish an investor’s wealth, instead of creating it. Match your philosophyWhen choosing your next investment, look for an institution with an approach or philosophy you understand and can relate to. For example, an investor who prefers a fixed rate, regardless of market

fluctuations may choose to invest in Ecsponent’s preference shares.

This simple and understandable investment option, which is congruent with your investment goals, enables you to make a focused decision about your wealth creation. Invest in yourselfAn investment in knowledge yields the best return. Invest in yourself by researching the asset classes and the underlying assets of the investment instruments. Explore the detail and compare products until you find an option suited to your needs. What do you want to achieve?Before investing, you should define your goals. Think it through, as this will help you to understand what you want to achieve.

Do you understand the markets?Investors can easily buy products which do not meet their needs and end up losing capital. How will you feel when you open your investment statement and discover the value of your retirement money has diminished by 30%?

The fluctuation in stock markets, interest rates and inflation will always affect investments. The key to risk management is to understand different types of risks and to invest in a product with risks that are acceptable to you.

Need is simpleThe average investor’s needs are simple. They want to understand and know, the expected: ▪ returns given the investment risk ▪ costs, if any ▪ taxes payable and ▪ degree of confidence in the investment company.

If a proposed investment meets all your requirements, go ahead. Break the ice. The longer you delay, the more you will lose, because time is money. Then trust the company to manage your money to your best advantage. Who calls the shots?You are responsible for your own prosperity. Each financial decision will have a short or long term effect on your finances. You need to understand and control your own money. Do not allow money to dictate to you.