Explore the essential considerations and risks associated with living annuities, including their legal nature and investment implications, to make informed retirement decisions. File photo.
I have written extensively about living annuities, how they differ from life (or guaranteed) annuities, and what to be aware of when using one to provide an income in retirement. But here I delve into their legal nature and what to be aware of when choosing a living annuity from a product provider.
At the risk of being repetitive:
• A life annuity: you “buy” a pension from a life insurance company with your retirement savings. In return, you receive a monthly income for the rest of your life.
• A living annuity: you invest your savings on an investment platform, choosing the underlying funds and deciding how much to withdraw – between 2.5% and 17.5% of the capital annually. You take on the risk of the investments producing the returns necessary to provide a sustainable income in retirement.
Insurance products
The funny thing about living annuities is that, although they are, on the face of it, investment products, they don’t fall under legislation that governs investments. Together with life annuities, which are insurance products, they fall under the Long-term Insurance Act, and the income you draw from one is governed by the Income Tax Act. There are no regulations on a living annuity’s underlying investments, apart from the fact that providers, which must operate under a long-term insurance licence, are subject to foreign exchange controls.
As I have mentioned before, the money you save for retirement (if you save conscientiously over your working years) is likely to be the largest amount of money you ever see in your life. Little wonder that financial product providers are eager for you to put this enormous sum into one of their products when you retire, and why there is fierce competition in this space.
This brings us to the question: why is the post-retirement investment space so loosely regulated compared with investments in retirement funds?
Retirement funds and Reg 28
Your pre-retirement savings in occupational pension and provident funds, preservation funds, and retirement annuity funds fall under the Pension Funds Act, which, among other things, places restrictions on what retirement funds can invest in. This is the well-known Regulation 28 under the Act, which has been relaxed somewhat in recent years.
Current investment limits under Regulation 28 include:
• Interest-bearing instruments (bonds and cash): no restriction
• Offshore assets in approved funds: 45%
• Listed equities, local and foreign: 75%
• Property: 25%
• Private equity: 15%
• Commodities (such as gold): 10%
• Hedge funds: 10%
• Any single company or entity: 25%
As you can see, a retirement fund may invest only 15% of assets in private equity (keep that figure in mind for later) and only 10% in hedge funds, which use derivatives. Funds are not allowed to invest in crypto because the regulators consider it too volatile.
While some investment professionals regard Regulation 28 as too restrictive, it follows the norms of prudential investing, which are to keep your savings diversified and to protect you from being over-exposed to higher-risk assets. You’ll note that the more risky the investment, the lower the limit.
What’s mystifying is that as soon as you buy a living annuity with savings you accumulated in a retirement fund, these protections fall away, just at the time you need them most.
Industry protections
To backtrack here slightly, not all living annuities are as unregulated as I have suggested. An in-fund living annuity, which is one offered by a retirement fund to its members, must comply with Regulation 28 because the retirement fund itself is subject to the Pension Funds Act.
Going outside retirement funds, you’ll find that most retail providers of living annuities offer these products via a linked-investment service provider (Lisp) platform, with a number of underlying collective investment schemes (unit trusts and exchange-traded funds) to choose from. Not only do these mainstream providers, through the Association of Savings and Investment South Africa, recommend Regulation 28 as a guide, but the underlying funds are regulated under the Collective Investments Schemes Control Act.
Private equity living annuity
What caught my eye recently is that there is a living annuity being marketed by a private equity investment company (presumably with a long-term insurance licence or through another party with such a licence). In this product, your living annuity investment goes 100% into an asset class which, in a Regulation 28-compliant portfolio, would constitute a maximum of 15% of the portfolio.
Private equity – shares in unlisted companies – is not well regulated, with very few protections for investors. If living annuities can invest to such an extent in private equity, what other “alternative investments” might providers venture into? Hedge funds? Derivatives?
I chatted with pension fund lawyer Brett Ladoucé, whose book “Pensions for Palookas” is an excellent introduction to retirement planning, voicing my concerns over what I considered a high-risk investment for pensioners. He agreed, saying that when life and living annuities were constituted under the Long-term Insurance Act, it was envisioned that they would use low-risk investments such as bonds and cash instruments.
Ladoucé also pointed out the risk to advisers of putting clients into such a product. Financial advisers are subject to the Financial Advisory and Intermediary Services Act, which requires them to do an assessment of your risk profile before recommending a product. A high-risk private equity product would not fit the profile of a pensioner who is dependent on the income from that product to live on.
One positive thing about a living annuity is that it can be transferred to another provider if you are unhappy with your current one.
Regarding financial advice, which is crucial in both choosing and managing a living annuity, there are advisers and advisers. If you have followed my column in the past you’ll know which type I recommend: one that puts your interests first.
* Hesse is the former editor of Personal Finance
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