How would you like to go into retirement in the knowledge that your money is going to run out when you reach the age of 80 Â but, if you had been sold the correct savings product, your capital would have sustained your required income flow until age 90.
The right product is a unit trust fund retirement annuity (RA). The evidence is provided in a paper entitled "Essays on Products and Planning", which was delivered by independent actuary Vernon Boulle at the annual convention of the Actuarial Society of South Africa (Assa), which was held in Cape Town this week.
The essays advance the watershed research presented by independent actuary Rob Rusconi at the same convention two years ago. Rusconi's research blew the whistle on the high costs of life assurance retirement products.
This latest paper is written in far more accessible terms than the Rusconi paper. You should read the full paper which is on the Assa website: www.assa.org.za. Go to the link for the 2006 convention documents.
Boulle tells me that he used plain English rather than "actuarial-speak" when he wrote the essays, so that we ordinary mortals could understand the full implications of being placed in the wrong product.
This week, we publish quite extensive reports from the Boulle essays and we also report in depth on the latest ruling by the Ombud for Financial Services Providers, Charles Pillai.
The two issues combined should make every financial adviser as well as life assurance product provider sit up and think.
Before getting back to some of the specifics in the Boulle essays, let me quote one paragraph from the most recent Pillai determination.
Pillai says: "Financial service providers are obliged under the Financial Advisory and Intermediary Services Act to explain the risk of a financial product to clients."
Based on Pillai's statement, I would suggest that you should be advised of the risk of running out of capital 10 years early because you are put into a more expensive product, particularly one where the commission is paid up front.
I would also suggest that any company that continues to sell a product which has a cost structure that reduces your ability to have a financially secure retirement will have some questions to answer.
Calculations
Now, to get to Boulle's essay number 10, entitled, "Product Comparisons", in which he makes calculations on a number of outcomes:
Option 1:
A life assurance retirement annuity (RA) where you take the full proceeds as a monthly pension at retirement.
Option 2:
A life assurance RA where you take the one third of the proceeds as a lump sum to reinvest the capital to provide a monthly income and use the remaining two thirds of your accumulated capital to purchase a pension.
Option 3:
An endowment policy.
Option 4:
A non-RA unit trust fund investment.
Boulle uses a number of assumptions but for his first calculation, the most important assumption is that all the costs are exactly the same for each product. He uses the 1.5 percent average for a unit trust fund.
What he finds in his calculations is that the two life assurance RA scenarios provide the best results.
The income stream from the two will last you until age 90, whereas the unit trust and endowment will only provide an income stream until age 80.
The reason for this difference is that Boulle has taken account of the tax breaks you receive for both RA life options.
The main consequence of the tax breaks come in the savings period because, within limits, you can deduct your contributions from tax.
One other interesting aspect of these calculations is that there is very little difference in whether you use the full amount of your accrued RA savings to purchase an annuity (pension); or you can structure your retirement income by taking and re-investing one third of your RA savings as a lump sum and you use the balance to purchase an annuity.
These two options offer different tax scenarios but, in the end, are neutral - they offer the same result.
But this is not the full story. Remember, Boulle applied the same cost structures on all four products.
As soon as he starts altering and making the cost structures more realistic, the picture changes entirely. And the picture is all in the graphic on this page.
Boulle drops the endowment out of the picture and compares:
- A life assurance RA on the initial assumed low cost (of 1.5 percent a year).
- A life assurance RA with a cost level that will bring it into line with a non-RA unit trust. Boulle seeks the level where the two will provide the same results. The result is about where the costs of an average life assurance RA actually are.
- A non-RA unit trust fund.
- A unit trust fund sold under the umbrella of a linked investment service product (Lisp) with an additional layer of costs.
Winner and contenders
The low-cost life assurance RA (which, remember, is a fallacy) remains at the top of the pile. If you can get it, your pension would last until age 90.
The non-RA Lisp unit trust provides an income until age 78.
But let's go back to the fictitious low-cost life assurance RA. So far, we have only dealt with a non-tax-incentivised unit trust.
Most unit trust RAs (this excludes the Lisp-RAs) will give you the optimal result of having your pension income stream maintained until age 90 because they do have the cost structure of the fictitious life assurance RA. Your financial adviser is obligated to tell you this.