RA top-ups: get the balance right
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Investors are wisely choosing “new-generation” retirement annuities (RAs) over traditional RAs, which have penalties if you stop or reduce your contributions.
New-generation RAs typically offer you a choice of underlying investments, mostly in unit trust funds, which you access through an investment platform. Since 2011, your choice of funds has had to comply with the investment guidelines set down in regulation 28 issued under the Pension Funds Act.
You should know what to expect if you are considering taking out an RA that allows you to choose the underlying investments, or, so that you can benefit from a tax deduction, if you are making an additional contribution to an existing RA that has investment choice.
The 2013/14 tax year ends on February 28, so there are a few days left if you want to set up an annuity or top up an existing RA and benefit from this year’s tax deductions, which will enhance your savings by at least your marginal tax rate (see “Do you qualify for a tax deduction?”, below).
If you are topping up an RA that was taken out after April 2011, you may also want to check whether your annuity complies with regulation 28, and if it does not, whether you should use your top-up to rectify any breaches.
If your RA was taken out before April 2011, when regulation 28 was amended, your savings are allowed to breach the investment guidelines, and you do not have to rectify the breach unless you change the terms of your RA contract. This means you can continue to make regular contributions to your savings, even if these result in your fund not complying with regulation 28.
However, if your RA was taken out before April 2011, you will have to align the investments in the RA to comply with regulation 28 if you, among other things:
* Make an ad hoc top-up contribution, as many fund members like to do at the end of the tax year to maximise their tax deduction;
* Change the underlying investments; or
* Change the amount that you contribute regularly.
If you take out or switch to a new-generation RA, you will probably be encouraged to invest in unit trust funds that are designed to comply with regulation 28. These are multi-asset funds, which are rebalanced regularly by their asset managers.
However, providers of new-generation RAs do not prevent you from making your own selection of funds – domestic and offshore equity, bond and property funds – as long as the combination of the assets in which these funds invest does not breach the investment guidelines.
Linked-investment services providers (Lisps) usually have online calculators that help you to determine whether your selection of funds complies with regulation 28.
The Lisp monitors your funds to ensure that, as the markets move up or down, their assets remain compliant with regulation 28. Your RA fund should notify you when your portfolio is in breach.
You are permitted to hold investments not in line with regulation 28 for 12 months as a result of market movements, after which you are expected to rectify the breach. If you fail to do so, your RA fund is obliged to rebalance your investments on your behalf.
Both Richard Carter, head of retail product development at Allan Gray, and Patrick Sheehy, head of product development at Glacier, say that, following the good returns on foreign funds and the depreciation of the rand, many of their RA fund members’ portfolios are now out of line with regulation 28.
Carter and Sheehy say that their companies will wait about 11 months and nine months respectively after your portfolio first goes over the limits in regulation 28 before asking you to act, because market movements during that period may bring your portfolio back into alignment with regulation 28. If members do not respond to requests to rebalance their portfolios and they still are in breach of the investment guidelines 12 months after their portfolios first went over the limits, Allan Gray and Glacier will rebalance their portfolios.
The Allan Gray RA fund has rules on how it will rebalance the portfolio. It will perform the minimum switches required to re-align your portfolio with regulation 28, and the switches will be made into the Money Market Fund.
Glacier will sell units or shares pro rata from all the funds that contribute to the breach and put the proceeds into a money market fund, because it cannot be seen to be giving advice on the funds or shares in which you should invest. Sheehy says Glacier’s clients use financial advisers, who are typically keen to rebalance to lock in good returns.
Pieter Koekemoer, head of retail at Coronation, says that Coronation notifies its RA members when their portfolios first go over the limits and waits until 12 months are up before taking action to rectify beaches of regulation 28.
Coronation will also switch your units into its money market fund to bring your portfolio back into alignment with regulation 28.
David Lloyd, managing director of investments at Liberty, says members of Liberty’s RAs that offer a choice of underlying investments can be out of alignment with regulation 28 for two or three quarters before Liberty will rebalance their portfolios.
Lloyd says that the requirement to comply with regulation 28 prevents younger people, who have many years until they retire, from having a higher exposure to equities that they ideally should have.
Carter says most RA members who have financial advisers understand that they cannot change RAs taken out before April 2011 without triggering the need to comply with regulation 28. They therefore choose to open new accounts instead.
Michael Prinsloo, head of employee benefits consulting strategy at Alexander Forbes, says that many RA funds are encouraging their members to make new contributions, without warning them of the consequences of contributing to RAs taken out before April 2011.
He fears that some investors may make decisions without appreciating the consequences.
Sheehy says Glacier immediately alerts anyone who tries to amend a pre-April 2011 policy of the consequences of their actions. It allows them to open a new RA without incurring the costs of a new RA.
Prinsloo says retirement funds are experiencing many problems obtaining data about underlying investments from managers, particularly if they are offshore funds.
It is not yet clear whether the Financial Services Board will amend the investment requirements in response to the breaches of regulation 28 reported to it, he says.
DO YOU QUALIFY FOR A TAX DEDUCTION?
Here is how to determine whether you can make use of the tax deduction for contributions to a retirement annuity (RA):
1. Add up your income from all sources (salary, allowances, rental, commission, business income, interest, but excluding capital gains) for the year. Subtract any exempt income and deductions – for example, medical expenses.
2. Calculate your income from non-retirement-funding sources. You do this by subtracting from your answer in step 1 the income on which any pension fund contributions are based (typically, your salary excluding any allowances or commission).
3. Work out 15 percent of your non-retirement-funding income. Compare the percentage with:
* R3 500 minus your pension fund contributions for the year; and
* R1 750.
4. Which number is the greater of (i) 15 percent of your non-retirement-funding income, or (ii) R3 500 minus your pension fund contributions for the year, or (iii) R1 750 is the amount you can contribute to an RA and claim as a tax deduction. But you must do so before February 28, or the deduction will apply only in the 2015 tax year.
From March 2015, the maximum amounts allowed as a deduction for contributions to a retirement fund, including an RA, will change.
REGULATION 28 INVESTMENT LIMITS
According to the Financial Planning Institute, the investment guidelines in regulation 28 are:
Listed property: 25%
Unlisted property: 15%
Equities and property combined: 75%
Maximum offshore exposure: 25%
Cash and money market funds with South African banks: 100%
South African government bonds: 100%
Commodities (Krugerrands): 15%
Hedge funds and private equity combined: 10%
INVESTORS SWITCHING TO LISP RAs
The growth in the sales of new-generation retirement annuities (RAs) through linked-investment services providers (Lisps) has been phenomenal, and, based on conservative estimates, Glacier expects that the Lisp RA market will surpass the life assurance RA market in the next five years, Jaco-Chris Koorts, an actuarial consultant at Glacier, says.
Jeanette Marais, who is in charge of retail distribution and client service at Allan Gray, says transfers from existing RAs are a large proportion of new business for Allan Gray’s Lisp.
RAs that have a choice of underlying investments typically offer a range of unit trusts from a variety of asset managers. You access these funds via an investment platform or a Lisp. Alternatively, you can invest directly, but exclusively, in the funds offered by the company that also provides the RA.
If you take out a new-generation RA, you can stop or reduce your regular contributions without incurring any penalties.
Many people are switching out of older-generation RAs, where a contract between the life assurer and you, the policyholder, binds you to contributing a certain amount for a defined period – with penalties if you break the terms of the contract.
The penalties are limited by law to 30 percent on RAs sold before January 1, 2009, and 15 percent on RAs sold after January 1, 2009.