Switching Your Retirement Annuity Fund is Now Possible - But Should You?

The Weekender / Business Day 4/5 Nov 2006

Until recently, if you were a member of a retirement annuity (RA) fund backed by one of the life assurance companies you were in many instances not allowed to transfer to another RA fund prior to reaching retirement age.

Now the pension funds adjudicator has ruled that RA funds’ rules be amended to allow members to transfer to other funds and draft legislation was published by national treasury that, if implemented, would allow RA fund members to move their savings to another RA fund of their choice at any time.

It is great news for retirment annuity fund members who were locked into old-style, high-cost and inflexible underlying investment products.

It will lead to greater consumer choice and strengthen competition in the industry.

But, before throwing the baby out with the bath water, I suggest you read on.

Determine first whether the investment contract underlying your retirement annuity fund has matured. If it has, it should be easier to transfer to another retirement annuity fund and should also be less costly to do so.

Note that even though draft legislation is on the table, you could still face early withdrawal-type penalties linked to the underlying investment product if you transfer from an existing RA where the underlying investment contract has not yet matured. If the RA fund of which you are a member has an underlying investment in a reversionary bonus or smooth bonus scheme, it may not be the best time to transfer your savings.

A reversionary bonus usually pays a greater return to those members who have been in the scheme for the longest period. It stands to reason that canceling close to maturity may be shooting yourself in the foot.

A smoothed bonus investment attempts to smooth the market. When the markets are performing well, a portion of the bonus will be held back and then released to members when the market weakens.

Many fund managers believe markets are at a high and expect the market to cool down soon. If you are a member of an retirement annuity fund that holds a smooth bonus portfolio as the underlying investment on your behalf, some of your returns may have been held back by the fund manager. Markets are currently volatile, and if they are about to begin to underperform, you want to benefit from the smoothing.

From the point of view of diversification, it makes sense to have your funds spread around a couple of good asset managers rather than having all your money invested in a single asset manager.

Switching to the asset manager that manages all your other funds is not a good idea. If that particular asset manager calls the market wrongly, it could cost you dearly.

You also need to be aware of your overall asset allocation. If your underlying investment is invested in a balanced portfolio, switching to an equity portfolio could result in your overall asset allocation being incorrect.

Any switch to another retirement annuity fund and/or to different underlying investments must be a long-term decision that fits into your holistic financial plan.

A simple calculation shows that if your underlying investment with Company A was worth R100 000 and returned 8% gross a year, your investment would be worth R466 096 in 20 years’ time. Assume that if you wanted to switch to Company B, it would cost you R15 000 in penalties and costs – this sounds like and is a lot of money. The result is that your fund balance with Company B is now worth only R85 000. However, Company B would have to return 1% a year more than Company A over the next 20 years to make up the penalties and costs.

Alternatively, Company B only has to be 1% a year cheaper than Company A. That is why it must be a long term decision.

Switches in and out of your underlying investment will destroy wealth. Even when switching to a new unit trust-based RA, you need to do a due diligence of the costs involved. The fees charged by asset managers vary significantly.

Many of the life assurance retirement annuity funds offer associated risk benefits. Unit trust-based retirement annuity funds usually focus on investment only and do not offer such associated risk benefits. You will need to consult your financial planner to assess whether, after switching to another RA fund, you still have sufficient life, disability and/or income protection cover, as these may be cancelled along with your fund membership.

On a more practical note, you need to take into account the time delay in switching your underlying investment. The draft legislation imposes time limits in which transfers must occur, which will hopefully ensure more speedy processes. However, research indicates that being out of the market even for a short period when the market is performing well dramatically reduces an investor’s long-term investment return. You don’t want your underlying investment to be sitting in cash while the markets are going up.

It may not be worth your while to pay penalties and costs to transfer your underlying investment if you are going to be retiring and transferring to a living annuity in the near future. The reason is that you will not have enough time to make up those investment costs, and on transferring to a living annuity, you are in any event allowed to choose the company to manage your living annuity.

It is well documented that in most cases, investors make poor financial decisions based on the emotions of fear, greed, fright and flight.

My advice is to engage an independent fee-based certified financial planner who is focused on your best interests, and who can provide impartial advice and take the emotion out of investing. Visit www.fpi.co.za to select a qualified certified financial planner.

Debbie Netto-Jonker, CFP™, is founder of Netto Financial Services and was financial planner of the year in 2001.