Do you need guarantees on you retirement savings?
More disclosure on smoothing coming — but you must evaluate costs vs benefits
Stock markets are scary places to invest when there are big falls in share prices. It can take a lot for us, as investors, to believe they will recover.
If you are saving for something like retirement more than five years away, you should not worry about a market fall. But many of us hate to see our savings balances go down, even if it may later go up again. And some retirement savers, against best advice, draw out their savings when they change jobs after a short two or three years.
For this reason, life assurance companies offer investments that smooth your returns – they keep back some of the returns earned when stock markets do well and to pay it back to you when markets don’t do so well, so your savings balance is more stable.
Sounds simple, but in practice investors, including many retirement fund members who have R190bn in these funds, haven’t always been treated fairly.
For this reason the regulator, the Financial Services Conduct Authority, plans to set conduct standards that oblige providers to tell you a lot more about how they will smooth your returns in a default investment option in your retirement fund.
Vesting or non-vesting
When assurers smooth your returns they declare bonuses but only a portion is definitely yours – it vests. The rest is “non-vesting” and can be taken away if the markets fall and the money invested on your behalf – called the funding reserves – falls a lot below the smoothed balance.
The regulator says life companies should explicitly tell you how they will invest, how they will calculate the bonuses and how low the funding reserves must fall before they will remove your non-vested bonuses.
The conduct standard also tries to prevent life companies withholding good returns longer than they should or taking their time to pay them out to you.
And it says life assurers must tell you upfront what they will do when the reserves are low – some “lend” shareholders’ money to the fund to boost the reserves and then recoup that loan from your future returns.
Andrew Crawford, CEO at pension fund consulting firm Shesego Consulting, says he has never seen shareholders subsidise the reserves. The reserves have always been restored by declaring lower bonuses in future and these low bonuses can persist for years.
Some life assurers say smoothed returns can show big losses so they guarantee you against a loss of 50% or 20% of your money.
This costs you more – close to 1% or more in addition to the already higher fee for smoothing. The regulator’s standard says you must be told what this charge is.
One percent may not sound like a lot, but just 1% more in fees can reduce your savings by 17% if the fee is compounded over 20 years.
The guarantees only apply if you take your retirement benefit at the point the markets are down. The chances of that are quite remote, Crawford says.
Meanwhile, every member in the smoothed bonus fund pays the inflated charges for the few that retire when the markets are down, he says. He believes there are better ways to protect yourself against these market falls.
Typically, retirement funds give you the option to reduce your exposure to risky shares when you can’t afford to take investment risk.
Crawford says members of umbrella retirement funds that cater for members from many different employers are increasingly being offered “these poor value investments where the gross returns become significantly lower after taking off these charges”.
But Chris Cooke, marketing actuary at Momentum Corporate, says a smoothed bonus investment can invest more in the stock market and potentially earn higher returns for you. If you earn higher returns this may offset the higher costs, but high costs will make poor returns worse.
Losses or very poor returns in the early years of retirement when you are drawing a pension can cause you to draw a high percentage of your savings that quickly depletes your capital to the point where your income will reduce in after-inflation terms.
Market level adjusters
Cooke says the guarantee means that if you die, resign, are disabled or retire, you will be paid out the full smoothed value even if the funding reserves are low.
However, if the reserve funding drops and you know you can expect low bonuses in future, you can’t just switch to a new investment without the life company reducing your benefit. It does this by applying what it calls a market level adjuster.
This is to prevent you from gaming the system – staying in while bonuses are good and leaving when they reduce.
The regulator says life companies can apply these market level penalties when you resign or there are mass retrenchments – just as there are now – after poor returns, as long as you are told about them when you sign up.
The regulator plans to make the companies tell you more, but it's up to you to take it all in and decide if it’s worth the additional cost.