161 - Upfront fees plus costs make for a bad investment

Question: I recently joined a company that has a group retirement annuity scheme. We all have our own retirement annuities, and the company pays the premiums with half of it coming off our income as a salary sacrifice.

I read a recent article of yours where you told us to look at the costs of investments. I have listed the costs below: 

These do seem high.

In addition to this, I see the broker is taking a fee of R69 every month when my R2 400 premium is paid.  He also receives an upfront fee of R6 290.

Answer: A group retirement annuity is ideal for small businesses.  It is a convenient and tax-efficient way to ensure that employees have a retirement fund. It requires very little effort in terms of administration from the company as all that is needed is that the company pay the premiums.

The compelling feature of a group retirement annuity is its flexibility. Each employee has his or her own investment and can invest in a very wide range of portfolios.  When they leave the company, they can continue paying the premiums themselves and have the policy continue. They can also stop paying the premiums and leave it paid up until they retire.

Now before we get into the costs, I would like to highlight a couple of structural issues of the investment that was proposed to you:

Upfront fees

A big red light comes on when I see that there is an upfront fee being charged.

As soon as an upfront fee is charged, the flexibility of the product is compromised.  You could find yourself in a situation where penalties are levied on the investment if you stop paying the premiums.  

When brokers are looking for upfront fees, they will typically use a retirement age of 65 instead of the more sensible 55 as this will give them a much better commission. Even if the company’s retirement age is 65, as you are taking out this policy in your own name, I would recommend that you use the age of 55 for the contract.

Fees

This investment does seem to have many layers of costs.  The R69 fee on each premium works out to 2.62%.  When we add this to the costs levied by the insurance company, you get a cost of 7.98%.  Now all these costs will have VAT added to them, so the true cost works out to 9.2%.

This means that your investment must return more than 9.2%, just to break even.

But wait, it gets even worse, there is that upfront fee of R6 290 that must be recouped.  This is more than 2 1/2 months’ worth of contribution.  I can’t see this investment breaking even after 2 years.

I would recommend that you have a chat to the company’s financial advisor and ask him or her for the following: 

• In the first year, how much of your R2 400 a month premium will be allocated to the investment once all the costs have been deducted?
• What would happen if you left the company and stopped paying the premiums for an extended period?

Group retirement annuities are great, but I would certainly recommend that the company uses a structure with a financial advisor is paid on an as and when basis. The typical fee that is used is a 1% up-front fee when the premium is paid and a 0.5% annual fee on the portfolio.

I prefer the new generation approach as it encourages the advisor to ensure that you are invested in the most appropriate portfolio.

Kenny Meiring MBA CFP ® is an independent financial adviser who helps people put investment and risk structures in place to live wonderful lives.  You can contact him on 082 856 0348 or at Financialwellnesscoach.co.za. Please send your questions to kenny.meiring@sfpwealth.co.za