This article was first published in the 4th-quarter 2015 edition of Personal Finance magazine.
An increasing number of small- to medium-size employers are offering their employees what are known as “group” retirement annuity (RA) products in preference to membership of an umbrella retirement fund.
Still in their fledgling stage, group RAs are individual RAs grouped together in a contract with an employer, allowing the employer to pay over the retirement fund contributions of its member employees in bulk to a financial services company.
Group RA sales are being retarded mainly by delays in the implementation of the government’s retirement reforms. The two main brakes are:
* Under current legislation, no one may withdraw money from an RA fund before the age of 55, while members of occupational retirement funds, including umbrella funds, can take their savings as cash when they leave a current employer before retirement.
* Tax deductions from taxable income are limited to 15 percent of non-retirement funding income for RA contributions, against the maximum of 27.5 percent of pensionable income for contributions to an occupational pension fund (7.5 percent for the member and 20 percent for the employer).
In terms of the government’s proposals, some of which are still being negotiated with trade unions, contributions to all types of retirement funds should be tax-deductible in the same way, and members of all retirement funds will be given only limited access to their retirement savings when they change jobs.
Group RA product providers are confident that there will be significant growth in their market share once the government’s retirement fund tax and preservation reforms are implemented.
Personal Finance has established that, currently, group RA business is small, with less than 10 product providers providing the facility to less than 1 000 participating employers and with less than R3 billion in assets under management.
Allan Gray, which launched the group RA in South Africa, has the biggest slice of the business, with 600 participating employers and 14 000 employees signed up, who have about R2 billion in savings.
Against this, according to the Financial Services Board (FSB) website, by mid-2014 there were about 1.5 million umbrella retirement fund members, who hold almost R200 billion in savings for their retirement – and the numbers are growing rapidly year on year. There are hundreds of registered commercial umbrella funds, but the vast majority of members and assets reside in 64 umbrella funds sponsored by 14 financial services companies.
The move towards group RAs is possibly being pushed by the following factors:
* Many asset managers, who manage billions of rands of retirement savings, mainly on behalf of stand-alone occupational retirement funds sponsored by individual employers, are seeing a reduction in their share of the almost R3-trillion retirement fund market, as the conversion from stand-alone occupational funds to commercial umbrella retirement funds gains speed, with a significant share of the assets being managed by the umbrella fund sponsor.
About 10 years ago, there were about 16 000 retirement funds, many of which were dormant. This figure has since been reduced to about 5 000 funds, with an increasing number of stand-alone funds transferring to umbrella funds.
* Higher commissions for advisers. Commissions and fees for umbrella funds are based on monthly contributions, whereas those for group RAs are based on your contribution and/or a percentage of a your total savings (assets under management), which means potentially higher adviser fees on group RAs.
There are a number of significant differences between group RAs and commercial umbrella retirement funds. Making the wrong choice could have an impact on your financial security in retirement.
Personal Finance has compiled 10 issues you should take into account before you sign up for either a group RA or an umbrella fund.
1. Legal nature
Commercial umbrella funds are pension funds established in terms of the Pension Funds Act. Pension fund lawyer and trustee of the Allan Gray RA fund, Vanessa Bell, of law firm Jonathan Mort Inc, says there are no provisions in the Pension Funds Act relating to the establishment of umbrella funds other than that an umbrella fund may apply for an exemption from having member-elected trustees if it has an independent trustee and the fund’s rules state that the fund is established for the benefit of members. The rules of umbrella funds allow the employees of many different employers to be members of a single fund.
There are two types of umbrella funds:
* Type-A funds: these are mainly commercial umbrella funds, which require special rules and provisions specific to each employer (such as retirement date and contribution rate) and are usually open to any employer/employee group or company. The funds are usually sponsored and administered by financial services companies on a for-profit basis.
* Type-B funds: these do not have special rules or provisions for different employers – the rules apply uniformly to all employers. The employers are usually limited to those in a particular industry, such as the building industry, or type of employer (such as local authorities). Trade union funds are usually type-B funds. Type-B funds do not usually have a commercial sponsor with a profit-making incentive.
Most commercial umbrella funds fall into the defined-contribution category, meaning that the contributions by the employer and employee are guaranteed but the pension is not guaranteed at retirement.
Umbrella funds can be either pension funds or provident funds:
* Provident funds. Employee contributions are made with earnings that have been taxed. At retirement, a member is entitled to take the full amount saved as a cash benefit, subject to taxation. However, the government has signalled that it intends to phase out provident funds (while protecting the vested interests of existing members) as part of its proposals to ensure retirement savings are used to provide a pension for life at retirement.
* Pension funds. Contributions up to prescribed limits can be deducted from pensionable earnings. At retirement, at least two-thirds of the proceeds must be used to purchase a pension for life.
Bell says the contracting parties of commercial umbrella funds are the fund and the participating employers, not the members. This means that the employers can make decisions without consulting members. Decisions include what umbrella fund to select, investment choices (without taking full account of the risk profiles of members) and the level of group life assurance.
When you leave the employer, for whatever reason, you are normally required to take the benefit as cash or transfer it to another retirement fund.
In a type-A fund, your retirement age is set in terms of the special rules of each participating employer’s sub-fund, with the maximum age likely to be 65. This will be the retirement age set by your employer.
A group RA as a concept does not exist in terms of the Pension Funds Act. It is a commercial innovation.
Bell says that, unlike being a member of an umbrella fund or a stand-alone retirement fund where the Income Tax Act requires that there be a participating employer, a member of a group RA is considered in terms of the Pension Funds Act simply to belong to an RA fund as an individual. The contracting parties are the member and the fund – the employer is excluded.
Bell says that employers that sign up for a group RA on behalf of their employees have no legal standing in terms of the Pension Funds Act. A group RA is simply an arrangement that allows for the simplification of administration.
John Anderson, the managing director of research and product development at Alexander Forbes, says employment contracts can include reference to group RAs to ensure that employees contribute.
Group RA product providers require employers to provide a monthly contribution schedule that lists the names of the RA members for whom contributions are being paid and the amount to be credited to each member’s RA investment account, and a monthly bulk payment that tallies with the contribution schedule.
But the underlying instrument is simply an ordinary RA.
An RA is an individual retirement savings plan with tax advantages. It has a tax structure similar to a defined-contribution pension fund or umbrella pension fund, with contributions, within tax limits, deductible from taxable income and where, at retirement, you receive a lump sum of which at least two-thirds must be used to buy a pension (compulsory purchase annuity) for life.
There are three main RA product structures:
* Life assurance RA. Your investment is in an underlying investment policy issued in terms of the Long-Term Insurance Act. Often, a risk life assurance policy is linked to this. You automatically become a member of the RA fund registered under the Pension Funds Act if you contract with the life assurance company to pay contributions for a predetermined number of years. This is known as an underwritten RA fund. If you stop paying or reduce your contributions before maturity, you will be subject, in most cases, to a penalty that can reduce the value of your accumulated savings by up to 15 percent on RAs sold after January 1, 2009. Some life assurance companies offer more flexible products, allowing you to alter your contributions without a penalty, but you pay higher ongoing costs. Life assurance RAs were found to be the most expensive retirement savings instruments by independent actuary Rob Rusconi in 2004.
* Linked-investment services provider (Lisp) RA. Lisps are essentially administration platforms that allow you to invest in a wide range of underlying investments offered by different companies and to switch between those investments. Lisps hold units in bulk accounts. For your protection, these bulk accounts must be held in the name of the Lisp, the retirement fund, or an independent custodian on your behalf. A Lisp RA is totally flexible: you can increase, decrease or stop your payments at any time without penalty.
* Collective investment scheme (CIS) management company RA. A CIS management company offers only its own CIS funds (usually unit trusts or exchange traded funds) as underlying investments. You are able to switch between these funds free of charge. A CIS RA is totally flexible: you can increase, decrease or stop your payments at any time without penalty.
There is no set retirement age for an RA member, but a member cannot retire before age 55 unless on the grounds of ill health. This means that you do not have to use the accumulated savings in an RA to buy a pension on the day you stop working after age 55. However, employer contributions to a group RA will cease once you are no longer employed.
2. Pre-retirement withdrawals
There is currently no obligation to preserve retirement savings if you leave an employer, whether it is by resignation, retrenchment or dismissal. In most cases when you leave the employment of a participating employer, you must choose to take your accumulated savings in full or partially as cash, subject to tax; or transfer your savings to another occupational retirement fund, RA fund or preservation fund, without any tax being payable.
Savings cannot be taken as cash before age 55 if you, as a member of a group RA, leave the employment of a sponsoring employer, unless the accumulated amount is less than R7 000, you are emigrating, or you are entitled to retire on the grounds of ill health based on requirements of the Income Tax and Pension Funds Acts.
All employees, as individual RA members, remain members of the RA fund if they leave the employment of the group RA employer. Their savings are accessible only from the age of 55 as a retirement benefit, when at least two-thirds must be used to buy a pension for life. Up to one-third may be withdrawn as cash, subject to tax.
Jaco van Tonder, the adviser services director at Investec Asset Management, says as an RA belongs to the member and not the employer. It does not cease to exist when the employee leaves the employer.
David Gluckman, the head of special projects at Sanlam Employee Benefits, says the forced preservation of an RA can be seen as both an advantage and a disadvantage.
He says most people do not retire financially secure because they have accessed and spent at least a portion of their retirement savings before retirement. “An RA limits this access to retirement savings and increases the possibility of retiring financially secure.”
However, he says, many people who are retrenched, particularly lower-income workers, need access to their retirement savings.
Anderson makes the point that with RAs you can transfer only from one RA to another RA, whereas with pension and provident funds, you can transfer to another retirement fund, an RA or a preservation fund.
3. Risk benefits
Risk life assurance benefits include cover provided on the death or disability of an employee, funeral assurance cover and even dread disease cover. The cover is also known as income protection assurance when paid as a monthly benefit on the disability of a policyholder. The benefits can be paid out as a cash lump sum and/or a monthly income.
Assurance against death and disability have historically been important elements of retirement saving. Group life assurance is attached to most occupational stand-alone and umbrella retirement funds.
The advantages of a group life scheme are that the premiums tend to be lower than individual assurance; there are no or minimal health checks for employees below a relatively high earnings level; and higher-income earners subsidise lower-income earners, both in premiums and because they tend to live longer and claim less.
Group life assurance comes in two guises: approved and unapproved policies.
* Approved policies. These policies are held in the name of the retirement fund and the benefit is promised in terms of its rules. In terms of the Pension Funds Act, the retirement fund trustees must decide who is entitled to the proceeds in the event of the death of a member. The employer usually pays the premiums to an assurance company. An employer is entitled to claim a tax deduction on the premiums.
Lump-sum benefits of over R500 000 are subject to tax on payout to beneficiaries.
* Unapproved policies. These policies are owned by the employer, not the retirement fund. The premiums are not tax-deductible, but the proceeds are tax-free. Employers often pay the premiums on behalf of employees and claim the payment as a tax deduction, if the benefits in terms of the policy constitute a service agreement with the employee. The premium is then considered a fringe benefit to the employee, subject to income tax.
Gerhard Klinger, the head of retail at 10X Investments, says the benefits of individual life assurance policies are not subject to the requirements of the Pension Funds Act and are paid directly and fairly rapidly to the beneficiaries nominated by the policyholder. However, this means that the money may not go to the policyholder’s dependants, unlike benefits governed by the Pension Funds Act, which requires that dependants take priority, even if they are not named as beneficiaries.
When the new retirement fund tax regime is implemented, it is expected that any group life assurance premiums will be added to your taxable income and will then be deductible as part of the total allowable deductions from taxable income (see “Tax”, below).
These products have no attached group life cover. Gluckman says that any group cover would have to be arranged separately by your employer, but it would be an unapproved policy. Failing this, you would have to ensure that you have sufficient life cover as an individual.
Pension fund lawyer Jonathan Mort, of Jonathan Mort Inc, says that members of both umbrella and RA funds are protected under the Pension Funds Act, but neither have the same rights as members of stand-alone occupational funds.
Mort says an area in which group RA members do not receive the same protection as members of umbrella and stand-alone funds is if an employer does not pay over member contributions.
In terms of the Pension Funds Act, contributions must be paid over by employers within seven days of the end of the month. Non-payment reporting procedures must be followed, and if payment is not made, directors or executives of companies can be held personally liable. Interest must be paid on the outstanding amount for the outstanding period.
The trustees of an occupational retirement fund are responsible for taking action to recover the due amounts from employers at no direct cost to the member. There is no such requirement on trustees of an RA fund, because the contract is between the member employee and the fund, not between the employer and the fund.
Mort says RA members would have to individually sue their employer and/or lay criminal charges of fraud.
All the group RA product providers say they have mechanisms in place to chase delinquent employers and to keep RA members informed of non-payment. These include reconciling the bulk payments of an employer against the individual RA accounts, advising members of under- or non-payment, and providing members with website access to their accounts.
Daryll Welsh, the head of product at Investec Investment Management Services, says the obligation for the employer to pay over contributions to the RA fund on behalf of employees needs to be embodied in employment contracts, because it is not in the rules of RA funds or in member application forms for RA funds.
Regarding the rights of members, other issues to be considered include the following:
* Elected trustees. Unlike stand-alone funds, where half the trustees must be elected by members, the boards of trustees of umbrella and RA funds are appointed by the sponsoring financial services company.
All retirement fund trustees, whether elected or appointed, are obliged to act in the best interests of members. Mort says, however, that where the majority of appointed trustees are employees employed by the RA sponsor, they also have duties to the sponsor. He says members may not be happy about not having the right to elect trustees, but, typically, the trustees of umbrella and RA funds have a high level of expertise.
Most umbrella fund sponsors now insist that participating employers establish joint committees with employees who are members of the fund, to ensure that the members are properly informed and play a role in the decisions made by the employer. The FSB has issued a draft directive for comment that will formalise these joint committees.
At least one umbrella fund, the Sanlam Umbrella Fund, gives members a limited right to appoint independent trustees.
No joint committees exist for group RAs.
* Employers. Initial contracts are between the umbrella or RA fund and participating employers, not with the members (the employees of the participating employers). This means that employers can make decisions in their own interests rather than in the interests of members when signing up for a fund.
In the case of RA funds, each employee must agree to the terms of the RA policy and the payment of any commission or fees.
If you are in an umbrella fund, Mort says that you cannot be transferred at the whim of your employer from one umbrella fund to another. The transfer must be approved by the FSB. Among other things, the FSB insists that a transfer is approved by the majority of the members.
* Reporting and advice structures. With most stand-alone funds, members have a direct link to their trustees. The trustees deal with the fund’s service providers, such as asset managers, advisers and providers of group life assurance, which are usually independent of each other. Most umbrella and RA funds have a commission-earning intermediary between the employer and the fund. In most cases, the intermediary has no contractual obligations to the members, only to the participating employer. Only the participating employer of an umbrella fund may fire an adviser, but with a group RA, the members themselves can get rid of their adviser.
* Fund rules. Type-A commercial umbrella funds have a main set of rules, with separate sets of special rules pertinent to each participating employer. These special rules could include the requirement for an employer/member committee and stipulate a fixed retirement age. An RA fund has one set of rules applicable to all members.
Currently, the tax regime favours umbrella funds over group RAs because of the potentially greater tax deductions, but this will change when the government changes how retirement savings are taxed. The reforms have been announced, but their implementation as been delayed.
It is expected that from March 1 next year – or at least by March 1, 2017 – the tax deductions for contributions to a pension fund or RA will be simplified and replaced with a uniform deduction for contributions to all types of funds, including provident funds.
Currently, you can claim up to 7.5 percent of your contributions to a pension fund (including an umbrella pension fund) against your taxable income. Your employer can contribute and claim as a tax deduction up to 20 percent of your retirement-funding income to your pension or provident fund.
You can claim 15 percent of your non-retirement-funding income from your taxable income for RA contributions. Your employer does not receive a tax deduction for contributions it pays to an RA on your behalf.
According to the 2015 Sanlam Benchmark Survey of retirement funds, very few members and employers come anywhere near the above maximums for umbrella funds. Average employee contributions are 6.42 percent and employer contributions average 8.8 percent, making an average total of 15.22 percent.
It is expected that, from March 1 next year, any contributions your employer makes to a retirement fund, including a group RA, on your behalf – plus any contributions to a group life scheme – will be added to your income, and you will be allowed a deduction of up to 27.5 percent of your taxable income, with a rand limit of R350 000. This will be on the combined contribution made by you and your employer, whose contribution will be added to your taxable income.
The tax deduction of 27.5 percent will become yours, rather than your employer’s, enabling you to use it fully, regardless of the extent to which your employer contributes to your retirement savings.
The costs of umbrella funds, particularly for asset management, tend to be “wholesale” charges, whereas RA funds have what are called “retail” costs for individuals, which tend to be higher. However, it is difficult to assess the actual costs of many umbrella funds, and they use different ways of reflecting their costs, making comparisons difficult.
Research undertaken by Personal Finance shows that the costs of both group RAs and umbrella funds are affected by a multitude of factors, including consultancy and advice fees, annual asset management fees, performance fees for active management, multi-layered fees where multi-management is used and the extent of investment choice.
So a group RA offered by a Lisp platform could be more expensive than a low-cost umbrella fund that allows members to invest in only in-house passively managed investment portfolios. Likewise, a limited-investment-choice, passively managed group RA portfolio may be cheaper than most umbrella funds where the underlying investments are actively managed – but even this may be affected by advice fees.
The Association for Savings & Investment SA (Asisa) is considering introducing a comparable “effective annual costs” measure to replace the reduction-in-yield measure of costs used by the life assurance industry and the total expense ratios used by the CIS industry.
The calculation of costs is complicated by the way advice fees are paid. Most umbrella funds pay advisers only a commission, calculated on the monthly contributions of members, whereas group RA providers may pay a commission on contributions (although in percentage terms very much lower than that paid by umbrella funds) plus an annual fee calculated as a percentage of the total savings of a member.
So an adviser will earn more by placing employees with significant assets and higher income into a group RA, but more from an umbrella fund if employees are low earners with minimal accrued savings.
Van Tonder says that for a young scheme with large contributions relative to the assets under management, it is likely that a group RA fee will be lower. For a more mature scheme with significant assets under management and a smaller monthly contribution, an annual fee on a group RA can indeed exceed the contribution-based fee of an umbrella fund.
He says there are other important differences in how advisers are remunerated by umbrella funds and group RAs.
With an umbrella fund, an adviser is paid a capped commission according to a scale, normally with a full year’s commission paid upfront. The commission is disclosed to the employer, which has the right to negotiate a lower fee. The commission is not disclosed to employees, who are not able to negotiate it.
With a group RA product, each individual member must explicitly agree to the advice fee when they sign up. The advice fee, it seems, at least initially, is negotiated by the employer. A member then has the option of not paying or amending the advice fee, which must be clearly disclosed on every quarterly member statement.
“The ability to negotiate the ongoing advice fee is a key lever at the disposal of fund members to ensure that they actually receive ongoing financial advice,” Van Tonder says.
A typical commission structure for an adviser selling life assurance-sponsored umbrella funds is 7.5 percent of the first R142 000 of the annual contribution, five percent of the next R103 000, three percent of the next R284 000, two percent of the next R1 021 000, and one percent of the balance. These commissions are regulated under the Long-Term Insurance Act.
When employers approach an umbrella fund provider directly, a combined administration and consulting fee is quoted, which is currently not governed by regulation.
The commission/fee structure for an adviser selling group RAs is:
* Initial fee: maximum of three percent a year, excluding VAT, deducted before the investment is made; and
* Annual fee: maximum of one percent a year, excluding VAT. If an initial fee in excess of 1.5 percent has been deducted, the annual fee is limited to 0.5 percent a year.
The different advice fee and commission structures for umbrella funds and RAs are currently under review in terms of the Retail Distribution Review, which is being undertaken by the FSB.
You need to take account of both the costs and efficiency of an administrator. A number of umbrella funds have run into serious problems because of the inefficiency of their systems, while some group RA providers had start-up problems with their platforms and still have minor glitches. Problems can result in delays in investing the savings of members and incorrect amounts being attributed to members.
In terms of existing legislation, occupational retirement fund members, including members of umbrella funds, do not have to be given individual advice, because trustees of funds assume that most of the responsibilities and the fund contract are between a participating employer and the fund.
Both umbrella fund and group RA providers hold educational sessions for groups of members, but most insist that this is the duty of financial advisers.
However, RA members, including group RA members, must be given advice in terms of the Financial Advisory and Intermediary Services (FAIS) Act unless an individual member states in writing that he or she does not need advice.
RA fund members may also bypass financial advisers and approach RA provider companies directly.
Van Tonder says umbrella funds typically aim to provide basic financial advice to all employees as part of the overall contract with the employer. In the group RA structure, every member contracts with the financial adviser separately for the level of advice they require, and pays a fee for that advice. Members can negotiate the fee or cancel it outright if they are unhappy with the advice they receive.
Gluckman says that he doubts whether the FAIS advice requirement can be properly met. “I think the requirement can be met for affluent RA members, but most South Africans are far from affluent,” he says.
The FAIS advice requirement is the responsibility of the adviser selling the product, not the product provider, unless there is no intermediary. Intermediaries selling the product must be licensed under the FAIS Act, administered by the FSB.
8. Conditions of employment
Mort says that, in terms of the Pension Funds Act and the Income Tax Act, an employer can decide on the class of employee it wants included in any occupational fund, including an umbrella fund. It is then compulsory for all employees in that class to be members of the fund. Generally, all employees are included.
Richard Carter, the head of product development at Allan Gray, says it is up to each employer if they want to make membership of a group RA a condition of employment, or make sign-up voluntary. The employer will decide who is included or excluded.
Van Tonder says Investec offers its group RA product to all employees of a single employer. It does not offer it only to higher-earning employees.
Old Mutual, which provides both umbrella funds and group RAs, allows for voluntary employee participation in its group RA. If employers want to put in place a compulsory retirement savings arrangement, they can do so via an umbrella scheme.
9. Investment choice
Investment choice is a hotly debated issue in retirement reform. The wider the choice, the potentially higher the costs, and research has repeatedly shown that most retirement fund members do not want to make choices and prefer to leave this to their fund trustees.
The 2015 Sanlam Benchmark Survey shows that while more umbrella funds are offering increasing investment choice, the number of members opting for default or trustee investment choice continues to rise, with almost 80 percent preferring to rely on the judgment of trustees.
Research has shown that where the members make investment choices, they often make the wrong choices, undermining their ability to retire financially secure.
All investment choice, for both umbrella funds and RAs, must meet the requirements of regulation 28 of the Pension Funds Act for prudential investing. Among other things, there are limits on how much may be invested in any asset class and in any underlying investments. For example, no more than 75 percent of your savings may be invested in listed shares and no more than five to 15 percent in the shares of any one company, depending on its size.
Umbrella funds can offer limited or wide investment choice. Choices include:
* Life assurance capital-guaranteed, smoothed-bonus investments. These products are extensively used by retirement funds. They provide various levels of capital guarantees at an additional cost and smooth market returns over good and bad investment years so that members do not suffer sudden investment losses when they retire.
* A wide range of portfolios, including actively managed funds with various risk profiles based on the percentage allocated to different asset classes, and so-called “lifestage” portfolios which reduce your exposure to investment risk as you approach retirement.
* Custom-made portfolios in which members may select the underlying investments, which are typically CISs, including unit trust funds and ETFs.
Most group RAs are offered on a Lisp administration platform. Investment choice can be very wide, offering the funds of many CIS management companies and even allowing investors to build their own share portfolios. In these cases, members must make their own decisions, with the help of an adviser, who earns a fee or commission from the product.
Companies such as Sygnia and 10X limit choice, concentrating on risk-adjusted portfolios, with passively managed underlying investments tracking various market sectors.
10X offers three risk-adjusted portfolios: a high-equity, medium-equity and low-equity option. There is a default “Glidepath” option, based on a mix of the three portfolios, which reduces equity exposure six years before retirement.
Sygnia offers a slightly wider choice. Its group RA range is limited to the regulation 28-compliant portfolios on offer on its Lisp platform. This includes Sygnia’s managed risk-profiled portfolios (three index-tracking funds and three multi-manager funds) and a small selection of large single-manager funds.
Some employers and product providers try to limit investment choice, but as the RA is held in each member’s name, the member retains the right to select from any wider choice offered by the pro-duct provider.
The product providers mainly pass the issue of investment choice on to the financial advisers selling the product.
10. Contribution minimums
There are no investment minimums for umbrella funds. Contributions, from both employer and employee, are based on a percentage of pay.
In most cases, the minimum contribution is R500 a month, but Allan Gray, for example, will accept a minimum contribution of R250 a month if the average contribution of all RA members within the employer group is at least R1 000 a month.