Average living annuity drawdown is 7.8%
By Wouter Fourie (CFP®) & Ryk van Niekerk
Those who make a living annuity decision without financial advice are making a mistake, says Wouter Fourie.
RYK VAN NIEKERK: Welcome to this Financial Advisor podcast, where I speak to leading financial advisors. My guest today is Wouter Fourie of Ascor Independent Wealth Managers, he was one of the founding members of the firm in 2003 and this firm offers a comprehensive range of financial planning services. Ascor has also recently been crowned the SA Independent Financial Advisor last year by the UK publication International Advisor. Wouter, welcome to the Moneyweb studio, this is a big prize, how does this competition work?
WOUTER FOURIE: Ryk, thank you very much for the opportunity and just to share the process with you quickly, the competition is hosted by International Advisor magazine, which is based in the UK, and the competition runs across the globe. So it’s not just South Africa competing, it’s countries from across the globe and then what they do is they have eight different categories to enter for this competition. We entered all eight categories and we were good enough to win four of the categories and then also be crowned as the overall winner of the Best Independent Financial Planning Practice in South Africa.
RYK VAN NIEKERK: It must be difficult for financial advisors to differentiate themselves from other advisors and I imagine many investors would Google the term financial advisor and then just see a list of names without knowing which one is the best. Do you see that awards like this lead to more feet through the door?
WOUTER FOURIE: Yes, we do see more enquiries coming through our website and yes, it’s good for the practice and it’s good for brand building in this industry as well. It’s also good to set a benchmark, it’s good to benchmark yourself against other practices and to know that you are competitive and to know that your service offering is compelling enough to win a prize like this.
RYK VAN NIEKERK: How should a potential investor go about choosing a financial advisor? I would imagine that it is a very critical decision because it will have an impact on the lifestyle of the investor when he or she decides to retire one day?
WOUTER FOURIE: Yes, it’s a very important choice to make. In most cases it’s a life-long relationship that you establish with your financial planner. So the point of departure is to look at qualifications and if we look at qualifications there’s a specific designation called a CFP designation or a certified financial planner designation and to obtain the certified financial planner designation you need to adhere to the four E’s as set by the Financial Standards Board based in the US and also accepted globally. The four E’s are education, as I said it’s qualifications, then experience, examination and also ethics, and that you obtain by being part of a professional body like the Financial Planning Institute of South Africa. I think the departure point when looking for a financial planner is to start with the Financial Planning Institute of South Africa and also to look for the CFP designation.
Number of registered financial planners in SA
RYK VAN NIEKERK: Are there many advisors who do not have CFP qualifications or are not members of an industry body?
WOUTER FOURIE: At the moment if we look at the statistics offered by the Financial Services Board we have about 150 000 registered financial planners or advisors in the country and of those we’ve only got about 4800 CFPs in South Africa. Also interesting is that South Africa is one of 26 countries across the globe that recognises the CFP designation. I think at the moment South Africa is ranked about number seven in terms of world rankings if you count the number of CFPs.
RYK VAN NIEKERK: But that’s a very small number, how difficult is it to verify that an advisor has the relevant qualifications?
WOUTER FOURIE: It’s not that difficult, first of all financial advisors have to be registered with the Financial Services Board, so it’s easy to check that, you can go onto their website and confirm that the person is registered and then secondly, you can go onto the FPI’s website and then you can verify the qualification of the specific person and if you can’t find it then contact the FPI and they will help you in terms of the enquiry.
RYK VAN NIEKERK: Wouter, a family member recently asked me to look at a proposal from a financial advisor and this proposal consisted of 50 pages but it was very complicated and this person didn’t understand most of it. I’m sure it adheres to all regulations but is this the norm in the industry?
WOUTER FOURIE: Yes, unfortunately we allow the regulator to specify the requirements when you deal with a client and I say unfortunately because I think it should be part of your ethics to deal correctly with a client and paperwork should not be the main source of confirming your ethics. But if we look at the current legislation, yes, it is difficult in terms of all the documentation, the preparation and so on that needs to be in place and the reason for that is if we look at the FAIS Ombud’s requirements when somebody is reported to the FAIS Ombud the first requirement is to show the paperwork and prove that you comply with the FAIS legislation and then also all the different aspects involved in it. So what we have found is that a lot of the advisors overcomplicate their documentation that they provide to clients. From our side we try and keep it as simple as possible and we make sure that clients understand what they are investing in. We rather spend two to three consultations with our clients and explaining it in plain English and allowing them time to digest it as well and to ask their questions.
Do prospective investors know enough to ask the right questions?
RYK VAN NIEKERK: But often you get smart people, qualified people, professional people but in other industries and let’s use engineers, for example, who feel they are very smart but they don’t question some of the content in such proposals because they feel they are going to ask a stupid question. Do you think prospective investors know enough to ask the right questions during such a consultation?
WOUTER FOURIE: That’s a difficult question to answer; you can’t force somebody to ask questions. My approach to it is I tell people from the word go that the stupid question is the one that you don’t ask because then I can’t answer it. So the process of explaining investments is we really try and simplify it to make it as easy as possible and I think it’s also part of the relationship that you have with the person, there’s got to be trust in this relationship to allow the person to feel comfortable enough to ask those silly questions.
RYK VAN NIEKERK: When I paged through the proposal my first thought was geez, this must have been very expensive to compile and I’m sure the advisor spent several days on it. I’m also sure that compliance plays a big role, there are many boxes to tick. How much resources, from an advisor’s perspective, does it take to compile such a proposal?
WOUTER FOURIE: Compliance is expensive and once again the whole idea of compliance is to embrace compliance, I think if you embrace it and you make it part of your business practice then it becomes one of your business structures and then it’s not such a big burden in terms of cost because it helps you to run a decent and successful business. But if you look at compliance, yes, it takes a lot of time, it takes a lot of costs in preparing a proposal for a client like that because there are extra costs that we incur and the costs are costs in terms of the research that we do. So we actually pay companies to do our fund research for us. The software that you use in terms of analysing the different funds and then also the compliance in terms of your documentation that you present to the client and also the consultation process that goes with that. So you can do two or three consultations just to make sure that you comply and that the client understands the whole process and then also to document this process and the agreement that you have with your client.
RYK VAN NIEKERK: Ascor is an independent advisor, which means you are not affiliated with any fund manager or any institution and you can invest your client’s money in virtually any fund. The other side of the coin is advisors who are affiliated with a particular asset manager and who are “forced” to invest funds in-house. How should an investor go about choosing between these two options?
WOUTER FOURIE: If we look at the requirements of the proposals of the RDR document that came out from the FSB, in future we will see that financial advisors will be categorised into two and maybe a third category. The first category would be a registered financial advisor with a specific company, so that person will work for one of the companies, life assurance companies, and they will only be allowed to market and advise on that specific company’s products. The other side of it is where you have registered advisors who are not linked to companies who have the ability to source products and solutions from a different or a big variety of funds and companies, and they can give you a bigger option in terms of investment portfolios. Then the third category is a designation as a financial planner, so you have financial advisors but only a certain group of financial advisors may call themselves financial planners and those are the planners who carry the CPF designation. It’s also been recognised by the FSB that there’s a difference between an advisor and a planner.
RYK VAN NIEKERK: But how should an investor look at it, you are totally independent but the affiliated advisors also have benefits or advantages they can offer to clients, which you can’t.
WOUTER FOURIE: That’s true, if you only like Toyota it has a very nice range of cars but if you only stick with Toyota you’ll never be able to choose a Mercedes or Porsche or Ferrari or maybe something more interesting. I think the problem with the one company and the one sphere is you don’t really have a big choice. I personally enjoy freedom of choice, I think that’s one of the benefits of being a human being is to have freedom of choice.
Trends in living and life annuities
RYK VAN NIEKERK: Just lastly, the living and life annuity products are starting to mature, I think they are 20 years, we’ve seen those products, what are the main trends you see there?
WOUTER FOURIE: So if we look at the environment and the history 20 years ago we saw that the defined benefits and the defined contributions started to change, so companies had a relationship with the employer and they gave him a specific defined benefit when they retire. That market changed and it gave us the defined contributions, which in fact means that you build up your pension fund until retirement and then you’ve got a choice of what to do with your funds. Then you’ve got the two choices, the one is to use a life annuity or a living annuity, a life annuity is underwritten by insurance companies, so they pay you a specific income for the rest of your life and you don’t take any market-related risks in terms of the growth of the portfolio. But it’s limited in terms of the funds that you pay over to the company because if you pass away with the first ten or 15 years all the funds that were paid over will disappear; it becomes assets of the company, so you give away your capital.
RYK VAN NIEKERK: So if you pick the life annuity you will get one amount, it will maybe be adjusted for inflation every year but the day you die you lose anything you may have on top of what was paid out to you?
WOUTER FOURIE: That’s right but the benefit of that is if you have a long life expectancy it protects you throughout your life, so you know you are going to get that income going forward. So if we look at the life annuities there are different categories of life annuities as well, so you can decide on a level life annuity, it means that you go to an assurance company, you provide them with your full pension fund and they give you a fixed amount for the rest of your life. The bad thing about that is you don’t get any increases on an annual basis. So a good example is in 1984 when I finished matric a friend of mines father earned a big salary and at that stage it was R1000 a month, now just imagine having a salary of R1000 a month at present day values, it’s really a cash flow killer if you don’t have an income that adjusts with inflation over the period.
RYK VAN NIEKERK: How many people pick the life option?
WOUTER FOURIE: Unfortunately about 90% of the people buying the life funds or the life annuities pick a level premium and inflation will catch up with them within the first seven years after they have taken it out. They also have an option to take out a life annuity with an escalation in the premiums but from the word go the guarantee, the level, pays a much higher amount than the escalating and that’s why we see most people buy into that specific product.
RYK VAN NIEKERK: But if you compare it to the number of people choosing a living annuity?
WOUTER FOURIE: If we look at living annuities about 80% of people buy living annuities compared to 20% who buy life annuities and I think one of the benefits of the living annuity is the fact that you can bequest the money should you pass away one day and I think that’s one of the biggest selling points. Also the fact that you can adjust your income levels according to your lifestyle, so you can decide at certain stages to bring down your drawdowns and at certain stages to take it up higher. Current legislation governed by the Income Tax Act is you are allowed to withdraw between 2.5% and 17.5% of your capital…
RYK VAN NIEKERK: Every year?
WOUTER FOURIE: …every year and it’s adjusted on an annual basis, yes. The danger of that is if you start off with a withdrawal rate that’s too high, if you start of at 7% or 8% you are going to deplete your capital too soon and you’ll find yourself running out of money very soon. There are certain standards that are set out to show you what drawdown rates are appropriate. I think it’s important that if you have a relationship with a financial planner is to make sure that you have that discussion about relevant drawdown options and also your asset allocation.
Living annuities versus life annuities, the drawdowns and drawbacks
RYK VAN NIEKERK: But another big difference between the living annuity and the life annuity is that the payments or the income you receive could be a lot lower, especially initially, for a living annuity and that may incentivise the investor to rather look at the life annuity, is that the case?
WOUTER FOURIE: No, we actually think it’s the other way around because on the life annuity you’ve got a fixed amount but on the living annuity you can go up to 17.5% from day one, which is not the right thing to do but you’ve got the option to take a higher amount. I think that’s one of the drivers behind it that people compare what they can get in a life annuity versus living annuity, they’re taking too high drawdowns on it and that’s why they think it’s a better product. So my advice to any person looking at retirement is you need to get decent financial planning advice when you make this decision. Throughout your life, building up to retirement, in most cases you have other people making choices for you in terms of your pension planning and if I say that most of us belong to pension funds and you have the trustees of the funds helping you to drive that but at day of retirement you take responsibility to decide how you are going to manage your money going forward. I don’t think most of us are qualified to make those important decisions on our own. We do see that most people buying living and life annuities do it without financial advice and I think there’s a big train smash waiting for them if they think they can keep on doing that without advice.
RYK VAN NIEKERK: The big risk being that your drawdown is too big. What is the average drawdown, the minimum is 2.5%?
WOUTER FOURIE: That’s right.
RYK VAN NIEKERK: How many people actually drawdown only 2.5%?
WOUTER FOURIE: What we did is we asked Allan Gray to do a comprehensive study of their clients on their investment book and they provided me with information two weeks ago, so it’s relevant and it shows us what it looks like at the moment. We see that the average drawdown rate is about 7.8%, which is not high but if you start off with an investment that’s a bit too high, you probably need to err more towards 4% on your withdrawals. We also need to look at the expectations of clients when they go into retirement in terms of how these funds will benefit them.
RYK VAN NIEKERK: But if you look at the JSE over the last few years the JSE hasn’t performed 5%, 6%, so the moment you take a drawdown which is higher than the JSE’s growth, for an example, you will actually see a reduction in your capital.
WOUTER FOURIE: Yes, you will and what we see is people enter retirement in different stages. So somebody who entered ten years ago has built up enough capital and enough funds in the portfolio because we’ve seen very nice returns on the JSE but if you look at the last three years we’ve actually had a very flat JSE. In fact, month-on-month some months it’s positive then it’s negative, so if we look at the last three years it’s going to have a huge impact on the portfolios of clients drawing too much from their living annuities.
RYK VAN NIEKERK: But annuities are not subject to Regulation 28, you can actually invest that money in any asset class you want?
WOUTER FOURIE: Yes, that’s correct and that’s also an exercise we did, so we asked Allan Gray to give us feedback on the asset allocation and specifically what we do is we look at the equity exposure in the portfolios. Most of the portfolios at the moment are sitting at about 45% equity exposure.
RYK VAN NIEKERK: Local equities?
WOUTER FOURIE: Equity including offshore.
RYK VAN NIEKERK: And the balance?
WOUTER FOURIE: The balance is in bonds and in cash in the portfolios.
RYK VAN NIEKERK: Have you seen that asset allocation change over the past few years?
WOUTER FOURIE: Yes, we actually have seen that. What that just reflects is that even though clients are allowed to invest outside Regulation 28 most of these pension funds are still sitting in balanced funds, which still require the Regulation 28 requirements, maximum 25% offshore, maximum 75% equity, so most people are erring towards the balanced portfolio environment.
RYK VAN NIEKERK: Thank you, Wouter. That was Wouter Fourie of Ascor Independent Wealth Managers.