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Q&A: What to consider when switching a client from an RA run by life assurers to an investment house

Published: December 19, 2013 by Peter Foster, Fundhouse

Our Q&A service provides you with the opportunity to pose difficult questions or to identify an issue that you would like us to research further.  Our aim is to respond to questions posed on the Q&A section of the site by either conducting our own research and reporting on our findings, or by approaching industry experts to share their views on the topic.


Question:

I am often asked to do an analysis for a client who has an existing retirement annuity run by life assurers.  It appears these portfolios are expensive, inflexible (clients can’t stop monthly premiums without incurring penalties), they have no investment choice (apart from the assurer) and are not transparent.   If we switch (section 14 transfer) to an investment house, there are costs/penalties involved which are clearly illustrated.  What considerations are there when deciding whether it would be better for a client to remain invested where they currently are or to switch, incur penalties but perhaps benefit from cheaper ongoing management fees in the future?


Answer From Fundhouse:

The question is a good one and it is a question that we are being asked by many Independent Financial Advisers out there.  The difficulty in answering lies in the fact that there are so many permutations.  All the companies charge different fees that have unique names and vary significantly in % terms.  In addition, the same company will have launched a range of products over the years so there is no one source for the costs.  Below are the key issues we would suggest you consider carefully before making any decision:

1. Is the client still contributing to the Retirement Annuity (RA)?

If the client is still contributing, one needs to consider the initial fees that are generally levied on the contribution.  These are real costs of running the RA that are often forgotten about.There are examples of “old style” RAs with up-front fees as high as 5% of the contribution plus a Rand based policy fee.  In addition, there may be an upfront “Guarantee” fee charged depending on the underlying investment.  This is rare but it is important to understand all the fees deducted from any contribution and what the fee is for.

2. What are the monthly fees paid on the current RA?

There are often as many as three different fees paid – administration fee, investment management fee and guarantee fee.  The administration fee and investment management fee can be bundled so that needs to be confirmed.   The ongoing guarantee fee may be charged depending on the underlying investment and this may take the form of a % of any return (say 10% for example) being deducted before being added to the investment value.  The company need to provide you with clarity on what all the fees are, and what they are for.  This would be detailed in the original policy documentation but the company would need to provide details if you request it.

3. What is the cancellation/lapse fee?

This will depend on a wide array of factors – the product, how long the client has been in the product, company specific, etc.  Again, this will be confirmed on request.  We have heard of penalties as high as 30%, but there is a wide range.

4. What are the fees payable on the “new style” RA?

This is generally fairly easy to ascertain – most have no upfront costs and ongoing costs are clear.

5. Investment return of underlying fund/s

While not only relevant to the question asked, it is important to check that the underlying funds are age/risk appropriate.  Our experience has been that clients were often placed in inappropriate funds when sold RA (e.g. you may find younger people invested in cautious funds when it is not appropriate).  If the investment options on the current RA are limited and generally poor, this can be very material on the future outcome due to the potential for lower future investment returns.  Apart from the differing levels of future fees following a switch, it is also crucial to consider the relative future investment returns from the two options.

6. Time until retirement

As the client approaches retirement, the time available to recoup the cancellation fee is less.