I recently co-consulted a client with another adviser with the aim of addressing the client’s retirement needs. The adviser recommended that the client invests in a retirement annuity (RA). Without a moment’s hesitation, the client said, “I’m not interested. I invested in a retirement annuity 30 years ago and it hasn’t grown in value since. It’s simply too expensive.”
It wasn’t the first time I heard that an RA is an expensive product and that it isn’t the best investment vehicle for retirement savings. Last week I proved that those who believed that an RA is not a tax-efficient investment vehicle, were wrong, and this week I’m going to tell those who believe that costs attached to RAs are too high, that they are wrong too.
Make no mistake, there is indeed an extra layer of costs attached to RAs (via a LISP or other investment platform) that direct investments such as shares, money market or even unit trusts do not necessarily have. But to determine whether this is really what makes the product so “expensive”, one has to consider both the sour side of those extra costs and the sweet side of its tax benefits to determine its true value to investors.
So, what is the average cost of an RA? Investment costs differ according to the size of the investment, so it’s definitely not a one-size-fits-all scenario. We analysed the standard fees on investments based on external funds as published on most provider websites and applied those fees to different investment totals. The table below summarises our findings and we learnt the following:
- The fees published on these websites are not necessarily the actual fees paid. You may end up paying less, depending on several factors.
- The funds/unit trust classes available on the various provider platforms are not necessarily the same, and this is of crucial importance to investors.
By analysing most of the RA providers’ cost structures, we have seen that depending on your investment total, your administration costs will amount to roughly an average of 0.5% extra per year without taking any adviser fees into consideration. Let’s also set aside the tax benefits this product offers (something which I believe justifies this extra fee all by itself).
Because RA providers invest such a large portion of their investors’ money in funds on other platforms, they are often able to negotiate cheaper fund classes with the fund managers on your behalf. But what exactly does that mean?
When you invest your capital directly in a particular unit trust fund offered by the same provider (excluding RAs and other investment products), chances are you are investing in their “retail” class fund (usually called an A-class fund). The cheaper fund class available via an RA is the exact same fund, only cheaper in terms of costs.
I put this theory to the test by calculating my Total Investment Cost (TIC), excluding adviser fees, by dividing my capital in five equal parts and investing each part in the top five largest SA Multi Asset High Equity Unit Trust funds respectively. Please note that I am only using these funds as an example, and that calculations may differ depending on the funds available for an RA investment, and the provider. According to the most recent fact sheets, my fees would amount to 1.59%, based on the last 12 months’ TICs (excluding adviser fees).
With no preference towards any particular provider/RA, I used the same amount of capital and invested in the same five funds, but in the cheaper classes offered on platform via an RA, and I was shocked by the results. By using the cheaper fund classes, I managed to knock 0.54% off the TIC, which amounted to 1.15% over the same period.
Again, I need to make it clear that the same saving will not apply to all funds or platforms. What I’m trying to illustrate here, is that by doing my homework (and without too much effort), I managed to justify the additional costs attached to an RA, simply by investing my capital on a provider’s platform that offered cheaper fund classes.
Don’t pay too much attention to the myths surrounding RAs. This product has changed tremendously over the last few decades and it now offers you amazing benefits, not only short-term benefits, but enough to last you until retirement and beyond. Most importantly, when it comes to weighing up costs make sure you are considering the bigger picture. With the end of February just around the corner, you can still invest in a brand-new RA or make an additional contribution towards an existing one before the end of the 2018/2019 tax year.
The opinions expressed in this blog are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice. This is intended as general information and does not form part of any financial, tax, legal or investment related advice. Although the utmost care has been taken in the research and preparation of this blog, no responsibility can be taken for actions taken based on the information contained in this blog. Since individual needs and risk profiles differ, it is always advisable to consult a qualified financial adviser before taking action.