Question:
Dear Sir/Madam We took out our first retirement annuities in 1996 and two of my husband's retirement annuities reached their maturity/were made paid-up. He opted to take 1/3rd as a cash lump sum and the rest in the form of a living annuity. However, the amount he was paid out was not close to the illustrative values given to us: 1. When we signed on the dotted line in 1996, the illustrative value on the maturity date was R196 000.00 (this is a small additional retirement annuity my husband took out ) - yearly contributions, R1 750. 2. This illustrative value just kept depreciating each year. 3. At the beginning of February 2014 we requested the value of the retirement annuity - illustrative value, R82 000.00 4. My husband completed and submitted the claim form and the final pay-out came to R77 000.00 WHY???
Answer:
Ilze,
Without full sight of your policy, and not knowing how your contributions were invested, we cannot give you a specific answer. But here's the generic problem: when a broker calculates the illustrative pay-out, he/she makes an assumption about the nominal growth rate (investment return) on your investment. Twenty years ago, the industry still projected nominal growth rates of 15%.
The nominal growth rates includes an inflationary component. Inflation has decreased steadily over the past two decades. In June 1996, average inflation over the prior ten year was almost 13%. At Dec 2013, average inflation over the prior ten years was only 5.6%. So as actual inflation fell, your illustrative pay-out would also drop, as the industry stared to adjust the underlying assumptions. At a point, advisers were in fact no longer permitted to projected a growth of 15% pa, only at 12% pa.
This inflation issue is a red herring however: if inflation had been higher, you pay-out may have been higher, but your money would be worth less. Your should really only consider your illustrative value in real (after-inflation) terms, for it to have any meaning.
The second problem is that the illustrative value ignores the fees that come off your investments. You probably paid fees of at least 3% pa. Fees have a destructive compounding affect, because they reduce your real return. On a balanced portfolio, you can expect to earn a real (after-inflation) return of around 6% pa over time. If you pay fees of 3%, you half that real return. Because of the compound effect, the you end up with less than half the money you expected.
Inputting your date in a spreadsheet, paying R1 750 pa for 18 years, with an illustrative value of R196 000, suggests a compound annual return of 18,8%. That seems high but could include an inflation assumption of 13%, and a real return assumption of 5.8%. Both these assumptions would be defendable back in 1996 (assuming that future inflation would mirror past inflation, although future inflation is in fact not predictable at all).
Actual inflation averaged only 6% over the past 20 years; adding (subtracting) a further 3% for fees would mean that your actual nominal return would only be 9.8% pa - that would give you a pay-out of only R78 000, which is close to what you received.
As we said, the inflation aspect of this is irrelevant; your main concern should be your high fees. The other point to consider is your actual investment return, which depends on your asset mix. We used a number of 6% above as a reasonable return on a balanced portfolio over time, but over the last ten years, actual returns were much higher. But if you were too conservatively invested, you would have missed out on some of this.
