Re­tire­ment ad­vice

The Laing and the short of it

Financial Mail - Investors Monthly - - Front Page -

I’ve just gone through a rite of pas­sage we all have to ex­pe­ri­ence at some stage: re­tire­ment. I found it very try­ing, so would like to share some of the harsh lessons I’ve learnt with you, dear reader, who I as­sume is 20-some­thing and thinks this is some­thing that will never hap­pen to you.

I’m re­tir­ing at a rel­a­tively young age, 55, and would have re­tired at 50 if any­one had told me I could. No­body did, which is why I’d like to share my wis­dom with you.

I’m leav­ing my job vol­un­tar­ily, a rare lux­ury for a mid­dleaged cor­po­rate wage slave in the mod­ern era. Many peo­ple my age work­ing in the in­for­ma­tion tech­nol­ogy me­dia in­dus­try find them­selves sud­denly herded to the hu­man re­sources de­part­ment like lambs to the slaugh­ter and or­dered to fill in a form ask­ing con­fus­ing ques­tions such as whether they want a “life an­nu­ity” or a “liv­ing an­nu­ity”.

Un­der SA’s pen­sion laws, you can take only a third of your pen­sion as cash im­me­di­ately, pro­vided this does not come to more than R500,000. Fur­ther­more, this limit ap­plies to your en­tire work­ing life. SA’s con­vo­luted pen­sion sys­tem does not en­cour­age por­ta­ble pen­sions, so peo­ple who job hopped early in their ca­reers and in­vari­ably built up too small a pen­sion to bother putting in a preser­va­tion fund need to deduct what they cashed in ear­lier from the R500,000 limit.

The re­main­ing two-thirds, or more if your pen­sion is more than R1.5m, has to be put into one of the two types of an­nu­ity, else the SA Rev­enue Ser­vice adds the en­tire lump sum pay­ment to your in­come for that tax year. Con­sid­er­ing that in­come over R1.5m is taxed at 45%, it is far wiser to hand the money to a pen­sion fund man­ager.

There is no es­cap­ing in­come tax on your pen­sion. But as most peo­ple are likely to end with an an­nu­ity pay­ing less than R195,850 a year, which places it in the low­est tax band of 18%, it’s a far wiser choice than let­ting the tax­man take nearly half your pen­sion sav­ings one fell swoop.

Hardly any­one knows the dif­fer­ence be­tween a life an­nu­ity and a liv­ing an­nu­ity, so cor­po­rate over­lords like to ad­vise those they are about to cull to con­sult a reg­is­tered fi­nan­cial ad­viser, prefer­ably their brother-in-law.

I was fore­warned of this by the his­tory of my fa­ther, who was re­trenched from IBM at 55. He was more of a cult mem­ber than an em­ployee, so the sud­den sep­a­ra­tion was like los­ing a limb, not just a monthly salary. Luck­ily, I’ve never been that emo­tion­ally at­tached to any em­ployer, much as I may have loved my col­leagues in the trenches.

What hap­pened to my fa­ther was fairly typ­i­cal of those who are cast out of the safety of a cor­po­rate laager: with­out any fore­warn­ing or prior ed­u­ca­tion, he be­came prey to vi­cious sharks who cir­cle life­long wage slaves to seize the pen­sions they have painstak­ingly built up over long ca­reers.

Writ­ing about per­sonal fi­nance over decades, I’ve of­fended many fi­nan­cial ad­vis­ers, who re­sent be­ing called things like vi­cious sharks. To pla­cate them, I’ll adapt an old joke of­ten ap­plied to jour­nal­ists and lawyers: it’s the 99% who give the other 1% a bad name.

No doubt there are ad­vis­ers who de­serve a large whack of their clients’ pen­sions for fill­ing in a form, but I’ve en­coun­tered only the hor­ror sto­ries of pen­sion­ers left des­ti­tute by meekly sign­ing doc­u­ments plac­ing their life sav­ings into dodgy in­vest­ments such as Share­max.

To briefly ex­plain the dif­fer­ence be­tween life and liv­ing an­nu­ities: a life an­nu­ity is the re­v­erse of life in­sur­ance. With life in­sur­ance you pay a lit­tle in ev­ery month and your next of kin stand to get a large pay­out when you die. But the in­surer wins the bet if you grow old.

With a life an­nu­ity, if you get knocked over by a bus the day af­ter trans­fer­ring your pen­sion, the in­surer gets to pocket your mil­lions; your fam­ily gets noth­ing. The longer you live to col­lect small monthly pay­ments, the more the in­surer suf­fers.

Life an­nu­ities tend to be what fi­nan­cial ad­vis­ers steer you to, and are usu­ally the de­fault in cor­po­rate exit forms. They are mar­keted as the re­spon­si­ble op­tion as they guar­an­tee you get some in­come un­til the day you die.

One of the draw­backs of life an­nu­ities is that the un­der­ly­ing in­vest­ments must con­form with reg­u­la­tion 28 of the Pen­sion Fund Act. In some ways this law is sen­si­ble, in that it forces pen­sion fund man­agers to do what they should be do­ing any­way — di­ver­sify. But a se­vere prob­lem with reg­u­la­tion 28 is that it forces the fool­ish in­vest­ment prac­tice of “home bias” by lim­it­ing the amount of for­eign eq­ui­ties a pen­sion fund may hold.

Some­thing I was not aware of un­til I opted for a DIY liv­ing an­nu­ity is that by choos­ing this op­tion, the menu of unit trusts you can buy is not limited to those that com­ply with reg­u­la­tion 28. Be­sides of­fer­ing wider in­vest­ment op­tions, a key dif­fer­ence be­tween a liv­ing and life an­nu­ity is that with a liv­ing an­nu­ity your pen­sion es­sen­tially re­mains your money, ex­cept that you can’t get ac­cess to it at a faster rate than 17.5% a year.

Liv­ing an­nu­ities have the ad­van­tage that if you die, your rel­a­tives get to in­herit what­ever is left in the kitty. The dis­ad­van­tage is that when the money runs out, you had bet­ter have some other source of in­come.

By shop­ping around for a liv­ing an­nu­ity from our var­i­ous pen­sion fund man­agers, I’ve ex­posed my­self to a lot of ser­mons about how go­ing for a liv­ing an­nu­ity is ex­tremely reck­less, es­pe­cially with­out the as­sis­tance of a fi­nan­cial ad­viser.

The forms gen­er­ally have a box to tick ask­ing whether you are do­ing this your­self or with the aid of a fi­nan­cial ad­viser, who is per­mit­ted to pocket up to 1.5%, ex­clud­ing VAT, of your ini­tial pen­sion, and then 1% ex­clud­ing VAT of the pay­out of your liv­ing an­nu­ity for as long as it lasts.

A gripe I have with our fi­nan­cial in­sti­tu­tions is that they go out of their way to make what should be rel­a­tively easy as in­tim­i­dat­ing and con­fus­ing as pos­si­ble, to drive po­ten­tial cus­tomers into the arms of com­mis­sion-earn­ing sales­peo­ple, or fi­nan­cial ad­vis­ers as they pre­fer to be called.

The forms for liv­ing an­nu­ities en­cour­age cus­tomers to se­lect sev­eral from the be­wil­der­ing ar­ray of unit trusts avail­able, and then al­lo­cate them dif­fer­ent per­cent­ages to cre­ate a com­plex pie. Backed by the the­o­ries of 1952 No­bel eco­nom­ics lau­re­ate Harry Markowitz, my ad­vice is to just pick one unit trust that rep­re­sents a well-di­ver­si­fied port­fo­lio of dif­fer­ent as­sets.

Con­ven­tional wis­dom is that the longer your in­vest­ment hori­zon, the higher the pro­por- tion of eq­ui­ties you want in your port­fo­lio. But I re­cently did an on­line course on as­set pric­ing, of­fered by the Univer­sity of Chicago, in which this was a trick ques­tion. Ac­cord­ing the “Chicago School” headed by Eu­gene Fama, the idea that time makes own­ing shares less risky is a com­plete fal­lacy and proved by com­plex math­e­mat­ics in­volv­ing some­thing called “Ito’s Lemma” — which I never en­coun­tered when I did univer­sity cal­cu­lus back in the pre­vi­ous cen­tury.

Some­thing of a joke for those who fol­low aca­demic port­fo­lio the­ory is that Fama shared the 2013 No­bel prize in eco­nom­ics with Robert Shiller of Yale. The rea­son was funny is that the two de­ride each oth­ers the­o­ries and don’t agree on any­thing.

Con­sid­er­ing the world’s lead­ing ex­perts don’t agree on the best blend of stocks and bonds, my ad­vice is just pick a “plain vanilla” ready-mixed unit trust with a port­fo­lio of about 30% bonds and 70% stocks, which is roughly what reg­u­la­tion 28 forces one to do. The unit trust with the low­est to­tal ex­pense ra­tio (TER) on of­fer is prob­a­bly the one you want.

As you’re not forced to go with a reg­u­la­tion 28-com­pli­ant unit trust with a liv­ing an­nu­ity, pick­ing one with a higher ex­po­sure to off­shore eq­ui­ties is prob­a­bly the way to go.

Most cor­po­rate em­ploy­ees end up with a life an­nu­ity, un­wit­tingly sad­dled with reg­u­la­tion 28 and tens of thou­sands si­phoned off by a fi­nan­cial ad­viser for do­ing lit­tle to no work. If that’s what you want, fine. But what con­cerns me is how many pen­sion­ers get lured into dodgy things like un­listed prop­erty devel­op­ments.

All peo­ple need to be ed­u­cated about what their op­tions on re­tire­ment are.

Even as a rel­a­tively fi­nan­cially lit­er­ate per­son, I found the in­for­ma­tion hard to find.

Life an­nu­ities tend to be what fi­nan­cial ad­vis­ers steer you to, and are usu­ally the de­fault in cor­po­rate exit forms

Pic­ture: 123RF — DAVID FRANKLIN

Robert Laing … there is no es­cap­ing in­come tax on your pen­sion

Pic­ture: 123RF — MARIGRANUL­A

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