Discussing the costs of retirement planning

In a recent interview with Blue Chip Magazine, Jannie Leach, Head of Core investments discussed the costs of retirement planning and how to make sure you are not paying too much. Read extracts from this interview here.

What are the costs associated with retirement fund planning? 

In the table below we summarise all the cost associated with retirement planning when using different savings avenues. The total costs associated with retirement planning are broken into the following three components:

• Total Investment charges (TIC) which includes the investment management fee as well as all other expenses incurred in managing the investment; for example the fee charges for underlying offshore investments, performance fees, administration fee of the investment vehicle and capital charges if guarantees are provided.
• Account administration fee which is typically the cost associated to administrating the investors account on a platform such as a Linked Investment Service Provider (LISP) platform or Umbrella Retirement Fund platform.
• Advice or consulting fee charged by a financial planner or Employment Benefit (EB) consultant for advice provided to investor or employer.

We have split the table into retail options which the investor will typically have to source themselves; and institutional employer options where the investor follows the guideline provided by his/her employer.

Retirement planning options for retail and institutional investors

* We have assumed an investment amount of between R100k to R10m and that the advisor uses three balanced funds in equal weights within the investor’s portfolio, one fund from the LISP provider to lower admin charges.

** The admin and consulting fees on umbrella funds are more complex than on LISP platforms. We have assumed that an investor uses the simplest options available on the platform (typically only in house funds). The EACs for the (institutional) employer retirement funds given ranges for a small newly started fund (R10m) to a mature fund (>R250m) where the admin and consultancy fees scale down significantly. We have assumed an annual payroll of R1.5m to calculate the EB consulting fee.

The retail investor has two options if guidance or advice is required: Firstly an Electronic Virtual advisor such as the newly launched Nedgroup Investments Extraordinary Life™ which provides basic guidance at low fees and secondly a financial planner who can also provide comprehensive advice which covers retirement planning and other services.

For the institutional employer options we have used a large umbrella fund with very low fees; for example administration cost on some umbrella platforms can be over R200 per member per month while investment costs (TIC) could also be well over 2% per annum. On this low cost platform we compared the Nedgroup Investments Core Range Life stage against traditional actively managed funds and smooth bonus funds. One can see that for newly launched employer funds the majority of the costs are dominated by administration and consultant fees (2.32% versus 3.19%) while for larger mature funds the investment costs (TIC) makes the biggest difference (0.62% versus 1.49%). 

What are the current trends regarding these costs? Do you see them increasing?

The total cost of retirement savings hasn’t changed much over the past ten years but the portion allocated to the different service providers do change from time to time depending on who owns the client relationships and the economies of scale involved.

For example a financial advisor can set up a range of fund of funds and reap the benefit of scale through lower investment management cost from the underlying asset managers. However, due to the fund of fund structure costs (white labelling and Manco fees) and Discretionary Fund Manager (DFM) fees the end client may still pay the same or even higher investment charges as before.

Regulation is probably the biggest driver behind increased costs as it has become more onerous to administrate and monitor the increasing scope of new regulation. This increases overhead cost on the various services providers and leads to increasingly higher barriers to entry into the financial services industry as a whole. Without economies of scale it becomes very difficult to compete in an industry where the different service providers are trying to maintain their margin by reducing cost from other providers in the chain.

Economies of scale also play a role in the costs that the end investor will pay for retirement planning. For example, platform fees and financial planning fees (percentage based) typically decrease for investors with larger investment amounts due to the fact that smaller investment amounts are quite often not feasible to service. This becomes apparent when one looks at the actual Rand amount paid to the different service providers. Traditionally it has been more onerous to manage 100 accounts than one which led to lower fees for larger investments.

In the institutional example above we could also see how size of an employer’s asset base impacts retirement cost charge across the fund. Large corporate pension funds may have EACs even lower than the ones listed above due to the scale achieved across all its members. Within these employer funds there is also cross subsidisation between high and low income earners as higher income members pay larger rand amounts as in the retail example above (R218 000 vs R3000).

What pressure does increased costs put on the financial planner?

Regulation, such as the Retail Distribution Review (RDR), increases the costs incurred by financial advisor businesses to monitor compliance and to prove that they have conducted the necessarily due diligence in selecting products and services. Many financial advisors opt to outsource compliance and investment management which increases their overhead costs, some of these will inevitably be passed onto the end investor. It also means that it will become increasingly more difficult for a financial planner to leave corporates or larger wealth planning networks to start up independent financial planning businesses.

Another factor which will also play a part in increasing the barriers to entry for new financial planning businesses is the proposed default regulation for post-retirement savings (in-fund annuities). The in-fund annuities offered by umbrella funds will make it very difficult for financial planners to compete against institutionally priced post-retirement solutions.

The disclosure of all costs (EAC) in the retail retirement planning has created an awareness of costs among end clients. We are seeing an increase in the adoption of low cost strategies such as the Nedgroup Investments Core Range and other “passive” investment funds. The reduction in TICs from using these strategies is quite often used to offset the additional regulatory expenses incurred in the retirement planning process. Demand for lower cost strategies from end investors is also driving financial advisors to allocate larger portions of their client’s portfolios to these types of funds. South Africa is, however, still 5 to 10 years behind the US in terms of the adoption of low cost strategies; in SA only 4% of unit trust assets is invested in low cost funds while in the US its 28%.