Financial Mail - Investors Monthly
Retirement advice
The Laing and the short of it
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