FINANCE: RAs - The Iceman Cometh
Recent Western Cape Business News
Recently released draft changes to Regulation 28 of the Pension Funds Act, which govern how the underlying assets of a retirement fund may be invested, are likely to make retirement annuities (long considered an astute choice of product for providing for one’s retirement) less beneficial for investors.
This is according to Darron West of Foord Asset Management who says that for many, a discretionary investment in unit trusts - more accurately called collective investment schemes - may be more advantageous.
So-called third generation retirement annuities (RA’s) are transparent and allow the investor the freedom and discretion to select the underlying investments. They also compete favourably on costs. Typically, RA’s have been favoured by investors with higher incomes who have sought to use the tax deductibility of contributions to RA’s to lower their immediate tax liability.
“Third generation RA’s are offered by a variety of platforms which have allowed considerable client discretion in selection of the underlying investments. However, this may well change,” says West.
“The purport of Regulation 28 is to provide prudential guidelines for the investment of the assets of a retirement fund; the rationale is that without such regulations, investment managers, or investors themselves, may invest the assets inappropriately or injudiciously.”
“The pretext of the proposed amendments is to update definitions and to take account of modern developments in the financial markets. However, they have also imposed some additional restrictions, not the least of which pertains to an RA investor having to ensure his or her individual compliance with Regulation 28’s investment spreading requirements. These restrictions may ultimately render the RA a fundamentally less desirable product, as RA clients who sought the apparent benefit of the tax deduction but the freedom to invest in pure equity or pure offshore exposures will no longer be afforded that discretion.”
According to West, the investment restrictions of Regulation 28 have always resulted in an astute investment manager being able to implement something short of a best investment view. This necessarily lowers the potential for returns (and, indeed, reduces the scope for the necessary and appropriate management of the risk of loss).
There may still be some who argue in favour of the RA based on the apparent tax benefits inherent in these products. However, Foord’s detailed and comprehensive testing of these perceived benefits has yielded quite different conclusions. “In principle, investors in an RA are obtaining a tax benefit on a relatively small invested amount. This amount should grow considerably, and the resulting annuity (conceivably a greater amount) will be subject to income tax. By contrast, whilst no tax deduction is offered on a discretionary investment into unit trusts, the later drawdowns are subject principally to the more benign capital gains tax,” says West. “We have considered the effects of estate duty (from which RA’s are exempt), variations in the taxable yield on unit trusts (on which a unit trust investor would be taxed whilst accumulating savings, and on which no tax is payable in an RA fund), differing pre-retirement income scenarios, measures taken by the revenue authorities to reduce fiscal drag, and a variety of accumulation and drawdown periods. The analysis shows that the discretionary unit trust investment, devoid of any upfront and seemingly attractive tax benefits, trumps the RA over time.”
West warns that in the mean time, investors should be aware that the RA is not necessarily a retirement funding panacea, and the prospect of well-intentioned but more restrictive, investment guidelines amplifies this notion.
Business News Sector Tags:
Fax 2 Email
Study IT Online
Work from Home