10X Investments CEO Steven Nathan tells the story that when he started working in the financial services industry it was said that 94% of South Africans were unable to retire with dignity. 20-plus years later the statistic remains applicable in South Africa.
This is in spite of the fact that in the intervening two decades, a lot of retirement savings products have been designed and sold, and billions of rand has been invested. So who or what is to blame?
The usual suspects – a poor savings culture in South Africa, high fees and underperforming portfolios – take the blame. No doubt some of it is well deserved. But the companies in the industry and the bodies that regulate them should also take some responsibility for the mess we find ourselves in.
Companies are allowed to disadvantage savers through the charging of upfront fees as well as exit penalty fees. I recently heard first-hand about this outrageous practice that is allowed to the detriment of retirement savers.
A client, a lady in her mid-40s who hopes to retire at 60, had recently discovered that the fees she had been paying for her retirement savings fund (for a couple of decades) were very high. She also realised that her portfolio was not performing well at all, and there was little-to-no chance she would reach the promised land of having enough money to sustain her lifestyle in retirement.
This investor decided to try to remedy her situation by switching her savings to 10X Investments, a provider that has a better track record of performance and, crucially, charges significantly lower fees.
A sensible plan, you might think but, sadly, the lady in question cancelled her plan to try to improve her chances of a decent retirement when she learned that she would have to pay a R100,000 penalty fee to move her savings. She just couldn’t stomach the loss of 12.5% of her investment total, so she decided to stay where she was.
If the financial services industry is serious about changing the fact that a mere 6% of South Africans can hope to retire with dignity, an obvious step would be to outlaw all onerous fees and penalty charges on retirement savings products. It is shocking that the industry has not done so voluntarily and scandalous that the regulators allow it.
BACKSTORY: EXIT PENALTIES
Many retirement annuities issued by life assurance companies carry “exit penalties”, which can be as high as 30% of the total investment balance. Describing these charges as "termination charges" or "penalties" creates the impression that policyholders are being punished for breaking a contractual term of the agreement and that these costs could be avoided if they stayed put, which is misleading.
The charges are an accelerated recovery of upfront costs, such as sales commission and administrative costs, incurred on the client’s behalf. These expenses are posted as a liability (debt) against the retirement annuity. This liability initially grows as the life insurance company charges interest on its loan; it reduces as fees are deducted from the investment.
The critical point is that these costs are usually recovered whether the client remains invested or transfers to another provider. They are recovered either over the life of the policy or as a "termination penalty". For all intents and purposes, these are sunk costs: they have already been incurred and will be paid one way or another.
In the past, there was no limit to the amount of the penalty and some investors forfeited their entire investment. Life assurance retirement annuities sold from January 1 2009 restrict the penalty to 15% of the investment value.