As a concept, retirement is a relatively new thing. Its roots can be traced to Otto von Bismarck and Germany in the late 1800’s where he introduced a disability insurance programme for anyone over the age of 70 (there were not many) and in reality it was just an attempt by him to retain the loyalty of the workforce. The first private pension fund was introduced around the same time by American Express in the US and shortly after this the first union pension fund was introduced. The uptake was initially slow but from 1910-1920 as favourable tax regimes were introduced the number of funds quickly grew to more than 200. By 1932 about 15% of the US workforce was covered.

Then came the “great” depression and in 1933 with 25% of the US population unemployed, 50% of the elderly living in poverty (many of the private pension funds collapsed) there was a growing call for the elderly to demand pensions from the government. They (the government) quickly responded and in a move that was mostly an attempt to maintain political power and control, FD Roosevelt and the new Dealers introduced the concept of enforced retirement. This was largely in an attempt to get rid of an ageing workforce and in doing so to make way for the young unemployed masses, thereby getting them off the streets and stop them from rioting as they had done in Germany and elsewhere. The plan to fund this was simple: get the younger members working and then use their taxes to fund the pensions of the older retired workers.

All that needed to be decided was the age of retirement. There were global precedents ranging from 60 to 70 (as well as the biblical notion of “three score and ten”). When they initially agreed on the age of 65, life expectancy in the US was around 63. In the 1930’s, if you reached 65 you were considered really old – kind of like today’s 95+ brigade. In reality, most people were set to die before they retired and the age was quickly reduced to 62 years. So, in theory at least, you retired at 62 and then spent a year in retirement getting your affairs in order before you then “checked out” for the last time.

Today, especially with the advancement of modern medicine, it is not uncommon to find people spending more years in retirement than they did working. Someone who retires today at 55 has saved for 35 years (max) and then possibly needs to fund the next 35-40 years from this saving. No wonder 9 out of 10 people will not be able to retire financially independent! It is not only that they have not saved enough but also that retirement was never meant to be that long. The odds are fully against us – how can you fund 30+ years (with all those deferred goals and with rapidly increasing medical costs) when you only have 30-40 years to save for it? Nope, I think we have it wrong and so do a growing number of well-respected financial planners.

But let’s go back to the early 1900’s for a bit. At that time there was a widely held view that the aged could add little value to society – part of this perception can be attributed to William Osler (so called father of modern medicine) who in his famous “fixed term” speech in 1905 stated that anyone over the age of 40 should be retired and that men older than 60 should be cholorformed. “Take the sum of human achievement in action, in science, in art, in literature – subtract the work of the men above forty, and while we should miss great treasurers, even priceless treasures, we would practically be where we are today. . . The effective, moving, vitalizing work of the world is done between the ages of twenty-five and forty.”

While his speech may have been partially tongue-in-cheek (he was 60 at the time) there was a growing perception that older people could no longer add value to society. Fortunately we (mostly) no longer think this and there are a growing number of older professionals still (happily) working – like the 87 year old doctor I met who was still studying (much to his son’s distress because he thought his dad should have retired already).

Life’s about balance they say and traditionally this has been about being a loyal and hard-working employee in order to earn money that you might be able to enjoy later. We’ve been encouraged to save our money and defer our dreams until one day when we have the time and money to do them. The “New Retirementality”* is shunning this idea and is opting to play now and then work longer. You might never get to retirement and if you do, you might not have your health or partner to enjoy it so let’s rather enjoy our money now (within reason) and work longer. The benefits are many-fold, here are just two:

1. We get to do the things we want to while we still can and with the people we love, and

2. It takes away the pressure to have a massive retirement pot to fund the unproductive years – with the power of compounding an extra 5 or 10 years of saving makes a substantial difference to the size of the pot eventually available.

People are also starting to realise that retirement is not just a financial event – rather it is a life event and if not dealt with on this basis it could have significant and far-reaching consequences. It is not uncommon to hear of people dying soon after retirement or even to find that many relationships come to an end as well. A person’s sense of self-worth quickly declines when there is no longer a purpose/reason to live. A decline in health and relationship stress often go hand in hand with this loss of purpose too.

So let’s accept that most of us wont be able to stop working at 65 and make peace with the fact that we will work longer…just make sure that if that’s the case that you enjoy doing what you do. If not, then find something that you love doing and that you can do for longer. Just make sure that you take time before then to stop and smell the roses along the way.

Retirementality* – this is taken from Mitch Anthony’s excellent book called the “New Retirementality”

This article was first published in Finweek – 25th Nov 2011

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About a month before our client died we sat with him and his wife to work through all his insurances (he had been diagnosed with terminal cancer). We did not do a lot of his old policies but managed to get a printout on his policies from the insurance company which showed that there was a death value of R233000 on one of the RA’s (the fund value was less as it still had a few years to run).

After his death we submitted the claim on behalf of his wife and received a recognition of transfer for an amount of R164000. We queried this with the company and were given the usual nonsense about the actuaries having calculated the values etc. We were not happy with this an insisted on a detailed explanation for the discrepancy in the values (this was in the form of at least 5 phone calls as well as 3 written requests).

Good news is that we have just received a revised recognition of transfer with a new amount of R247000 – that’s 50% more than the first one!

Still no explanation of how the value was calculated and no apology. I think we will take the money and run and then follow up later with a further request for a detailed explanation.

Now, imagine that this was a direct client with no advisor fighting for her – the insurance company concerned would probably just pocketed the extra money and the client would have been none the wiser!

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I cant understand the motivation behind treasury and the FSB’s latest (very zealous) implementation of the regulation 28 rules that apply to retirement funds.

These rules have a whole host of unintended consequences, not least of which, will probably be that RA’s are no longer used as savings vehicles and especially by younger people.

First a brief bit of background:

The Prudential Investment Guidelines (PIGS) are part of Regulation 28 that has been applied to pension funds and how the assets can be invested. Without getting into too much detail, the past rules stipulated that in terms of PIGS, funds could have a maximum equity exposure of 75%, property and equity was limited to 90% with the balance of the funds being invested in the other asset classes (bonds and cash). Typically “pension” funds have tended to sit with around 65% in equities, 10% in property and the balance of the assets in bonds and cash. On top of this, funds were allowed to have up to 25% of their assets invested offshore.

Now most companies tended to allow individual investors to do as they please so long as the fund as whole complied with the regulations. In practise this meant that because some investors were more conservative and had most of their money in bonds and cash, others could be more aggressive with some investors (typically the younger ones) having 100% in equities. The same applied to the offshore exposure. This seemed to work fine for just about everyone. Or so it seemed…

However, recently, the national treasury and the FSB saw fit to amend Regulation 28 (I still cant figure out why) and the worst part of the amendment seems to be that they want each individual member to comply with the legislation with some talk of them even forcing members to comply. This could mean that the companies would be forced to switch some individual members funds until they comply (that could be a legal nightmare). Talk about big brother watching you!

Going forward, 2 of the unintended consequences that I can already see are as follows:

1. Anyone who has an existing RA will have to make sure that it complies with the regulations before they can add to it (this will even apply if they want to increase an existing debit order). Practically this will have the following effect: I have an existing RA where the equity exposure has grown to 78% and the offshore exposure is sitting at 30% of the fund. I am happy with this but I will now not be allowed to add to this RA fund unless I reduce the equity exposure to 75% and the offshore exposure to 25%. Now there will certainly be times when this might be appropriate but there are also times when investors will not want to reduce equities or their offshore exposure (for example when the market is weak and the rand is strong – it would be a classic case of buying high and selling low – and this enforced on us by the regulators!). The practical solution will be to leave the existing RA as it is and start a new RA at a different company. This exercise could be repeated each time investors want to add to their RA’s and it is not inconceivable that they could end up with 10-15 different RA’s at 10-15 different companies over the years – this is an admin nightmare for everyone.
2. A second unintended consequence will be that younger investors who up until now have been able to invest 100% in equities will now shun RA’s in favour of discretionary funds where they can determine their own asset allocations. Sure there are no tax deductions and they will probably end up accessing the funds before they retire but that’s what you get when you try to force an inappropriate situation onto people. Why should a 30 year old investor with 35 years to go until retirement not have 100% in equities if she wants to?

I cant see why the new regulations have been introduced and more specifically why they seem hell-bent on enforcing them at individual investor level – it is certainly not about protecting investors from themselves – under the new rules, it is now possible to have 75% of your fund in equities and the remaining 25% in property – that is certainly not lower risk than the previous guidelines and will certainly mean more volatility for anyone who opts for this route. So what are the real intentions behind this all?

In our practice, we are very close to advising investors to stay away from RA’s until they are ready to retire – at retirement age they could transfer their discretionary assets into an RA. Under current legislation this would have multiple tax benefits for them.

Is anyone at treasury or the FSB listening to investors?

This article appeared in Finweek on 14th October 2011

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The basic argument goes around the fact that in a retirement fund an investor may not have more than 75% of his/her funds invested in equities and by default most investors tend to opt for “balanced” funds. Although balanced funds can have 75% equity exposure, most, in reality, do not and they tend to err on the lower equity side.

As a result of the lower equity exposure, a balanced fund will under-perform an equity fund over long periods of time.  In fact, Mouton’s article suggests that as a result of the more “conservative” asset allocation, an investor in a retirement fund could have less than 1/3 of the money that an investor in an equity unit trust fund could have. Scary stuff indeed and certainly it sounds like a compelling reason not to use retirement annuities – especially if you are young. Or is it?

Let’s take a different look at the case and let’s assume that the chosen equity fund (outside of the RA) gives a total return of “x” over the period. Now if we use the same equity fund within the RA we could invest 75% of the contribution into this fund – the balance of the money would have to go into the other asset classes and for the purposes of this example let’s refer to that as “cash”. Over the investment term, the RA would then give the following: 0.75x + “cash”. Clearly this is less than the equity fund.

But this is where the financial planner in me comes out…

One of the primary reasons for using an RA is because of the tax saving involved. For every rand you contribute, you receive a “rebate” equivalent to your marginal tax rate. Simply put, if your marginal tax rate is 30% you will only effectively pay 70cents in every rand of the RA premium – the 30cents is the tax saving. Now if you are disciplined you can invest this amount and if we use the same equity fund used above, then over time your return will be 0.3x (or your marginal rate * x).

So your total “RA” return now becomes: 0.75x + “cash” + 0.3x.

This is equal to 1.05x + “cash” (this could be as high as 1.15x + “cash”).

Even without the “cash” portion, 1.05x > x (apologies for the maths but you should have paid attention in class!). And then it is also possible to invest the “cash” portion into a property fund – which would be significantly better than “cash” over the long term.

Now this is where the detractors of RA’s will jump up and say “yes but there will be tax on the income taken from the RA whereas there will only be capital gains tax payable on income taken from the equity fund”. You are correct and this could well be less than the income tax payable on the RA income.  However, at death, there will be estate duty payable on the equity fund whereas the money in the RA will fall outside of your estate (there will also be no executor’s fees on it).

I am sure that there many responses possible to this article, not least of which would be to make sure that the voluntary money was invested via a trust but that has another whole set of implications. The point of this article was to show, mathematically, that there is still a case for RA’s.

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There are currently more than 15million South Africans who receive some form of State Social grant. Clearly this is not sustainable but more concerning than these figures is the perception that if one saves and acquires “wealth” during one’s working life then you will not qualify for a state pension. Something is seriously wrong when people are discouraged to save for the sake of receiving a pension of R1140pm.

There is currently fairly complicated way of working out who qualifies for state grants. For an old age pension (for 2012 tax year) it is as follows: anyone earning less than R13680 (R1140*12) per annum will qualify for the full pension. The pension decreases proportionately as the income rises and anyone earning more than R44880 pa would not qualify for any old age pension. In addition to this there is an “asset” test and anyone with assets of more than R547200 (excluding the value of their house) would also not qualify for a pension*.

Clearly there is a lot more education that is required – people need to be encouraged to save, even at the risk of not qualifying for an old age pension. The current situation, just like defined benefit pension schemes, is not sustainable. More people are living longer and there are not sufficient new members entering the “scheme” to continue to cross-subsidise the elderly. Something’s got to give – and it cant continue to be government!

Note: R547000 invested into the RSA Retail Bond (2 years at 7.25%) would currently generate about R3300 pm and would still allow someone to qualify for a partial grant. R44880 pa equates to around R3740 pm. In addition to this it is my understanding that any money in a retirement product is not regarded as an “asset” and so workers should be encouraged to save into retirement products…even R1million in a living annuity with an income draw of 2.5% would still provide an income that is below the current old age pension threshold and would still allow pensioners to qualify for state assistance.

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Taxable income: R250839

Tax on this (after rebates): R44142

If she put 15% of her taxable income (R37626) into an RA then her tax for the year would reduce to R33243.

So if she spends R37626 (on herself now) she will save R10899…

She either pays R44142 to SARS and gets “nothing” or she spends R70869 (R37626 RA + R33243 tax) and gets R37626 in an investment for herself. It certainly puts a new “twist” on the “got to spend money to make money” saying and of course it’s all about cash flow.

In this instance, because of the tax saving on offer she effectively pays 71% of the premium into her RA (R10899/R37626).

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But that is not the point of this post – the other kind of annuity at retirement is a life annuity – typically this is sold through an insurance company. You give them your capital and based on a few things like your mortality (age & sex) as well as interest rates, they contract to pay you an income for the rest of your life (at death the capital usually disappears – but that is not the issue here).

According to stats*, 90% of these annuities have no annual escalation on the income! This means that if you take one of these and live for 30 years, you will still be drawing the same income in 30 years time! At an inflation rate of 6% per annum an initial income of R1000 will effectively have reduced to R156 pm at that stage. Talk about erosion of income and yet nothing has been done about this by ASISA – they seem to be turning a blind eye to what is an exceptionally bad business practise and one that should have been outlawed years ago. If living annuities are subject to a code of conduct then life annuities should also be subject to one. And the first point should make it compulsory for Life annuities to have inflation linked increases on them. I cant think of any valid reason for not including one. The only possible reason is that if there is an escalation then the initial income will be lower and at “quote stage” this might not look as attractive to the client resulting in a “lost sale” and so the escalation is left off to make it more appealing (initially that is).

I have come across far too many “little old ladies” who are locked into these annuities and are still receiving the same income that they started with – they have not been “protected” against loss of income by anyone!

*http://www.iol.co.za/business/business-news/sa-s-pension-pot-has-little-lustre-1.723161?ot=inmsa.ArticlePrintPageLayout.ot

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RA’s have received a lot of press (not all of it good) and as a result there is probably a great deal of confusion about whether or not they are good investments. So let’s look at a few of the “issues:

• RA’s are effectively “private” pension funds and as such they are most appropriate for people who have taxable income and who don’t belong to a pension fund. They are also great for commission earners.
• Subject to tax limits, contributions to RA’s are tax deductible – this means that for every rand that you invest, the government is effectively subsidising your contribution and effectively “loaning” you money to invest until you retire.
• Yes, RA’s are subject to restrictions and are taxed when you retire but the tax rate at retirement (i.e. after 65) is significantly lower than pre-retirement (for most people that is).
  

In my opinion, RA’s are great investments. However, not all RA’s are equal. Don’t ever invest money into an RA through an insurance company – you are contractually committing yourself to a long-term relationship where there will be penalties when you want to leave it. Contractually binding someone to a 30 year product is an archaic way of doing business.

Here is how the “insurance” RA works. You agree to pay a given premium, escalating at some number (inflation) for a given term. The insurance company then works out all the future “profit” from this contract and accounts for it today. As a result, if at any stage in the future, you want to adjust the premium down or reduce/remove the annual premium escalation, you mess with their profits and as a result, they penalise you for it. And very often, this penalty bears little or no resemblance to the actual “loss” of profit. For policies issued prior to 2009, the penalty is usually 30%, while for policies issued after Jan 2009, legislation has reduced the maximum penalty to 15%. Very often people have to reduce/stop their premiums through no fault of their own e.g.  loss of employment, forced to join the company pension fund. In such circumstances, it is fundamentally and morally wrong to penalise the investor. But that’s the fault of the way the product is structured.

So if you should never ever use an RA through an insurance company, which RA should you use? Unit trust RA’s are a much better option – there is no contractual obligation! You pay a premium as and when you want/need to and the costs are taken off as and when you pay. You can change your mind as often as you want/need to and will never ever incur a penalty for doing so.

So why are more people sold unit trust based RA’s? The very simple answer is because of the commission structure on insurance company RA’s. Consider the following example: a 30 year old takes out an RA for R1000pm.

• Through the insurance RA they need to “commit” to a term and so they agree to pay until they turn 55 (that’s the minimum age) and agree to a 10% annual premium escalation. The commission on offer to the salesperson would be R1304.40 upfront (paid in advance) and R25pm (escalating with the increased premium).
• The same RA though a unit trust company would pay the salesperson a maximum commission of R30 per month each time the premium is paid (this will also escalate as the premium escalates).
• So while there may be little difference in the total commission paid over the term of the RA, there is an incentive to earn upfront commission on the insurance based RA…and if you have a sales target then it is pretty obvious which one you are going to favour.

To summarise then, RA’s have an important role to play in helping investors to save for retirement. There are significant tax incentives when RA’s are used correctly. A contractual based RA (such as the insurance company RA) is an archaic way of doing business – stick to RA’s where there are never any penalties for changing your mind about the premium.

*for those that remember “Squad cars” on Friday evenings on Springbok radio way back before TV in South Africa.

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The current tax limit on RA contributions is R1750 per annum (there are a few provisos to this amount) but for all intents and purposes, the average man in the street who belongs to a pension fund and who wants to supplement his retirement savings via an RA is limited to this amount (by way outdated tax limits).

But here is the problem – you cant get into a unit trust RA with this amount. You need at least R250 and in most cases at least R500. When you ask the Manco’s why they all say it has to do with bank fees and the cost of debit orders, blah, blah, blah…

Somehow the Life insurance companies manage to do it – so either their systems are more efficient or they are making an absolute killing on the products (or both).

But the bottom line is that if you dont have R500 per month to put into an RA you cant use a unit trust RA and if you want to get any tax relief and only qualify for the R1750 then you are being forced into an inferior product. Not only is the life insurance RA significantly more expensive, but it also carries significant penalties if you alter the contract at any stage.

So if you are faced with the choice of a life insurance RA or no RA then I would stay far away from any retirement annuities…

My quesiton is so where are the legislators and where is the Miniser of Finance when it matters? Seems that unlike unit trust RA’s, talk  is cheap!

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For those that are not familiar with preservation funds they are essentially a vehicle into which can transfer your pension or provident fund if you leave your employment before retirement…the money is invested into some unit trust (or similar) funds and will remain there until such time as you reach retirement age. In other words, your pension fund is “preserved”. The transfer is “tax neutral” i.e. there is no tax on the transfer and one of the attractive options available with a preservation fund is the “once-off” withdrawal option. This is done before retirement age and can be a portion of the fund or the full amount.

Currently if you withdraw from your preservation fund before retirement you will receive the first R22500 tax-free. The balance of the amount will be taxed according to the “pre-retirement” tables with the next R577500 being taxed at 18%, the next R300000 at 27% and the balance at 36%. Not too bad you might think…and indeed it isn’t, right now. But the problem comes at retirement when you want to take the 1/3 lump sum out of your fund…any amount that you have taken out before retirement will be taken off the tax-free portion available to you at retirement (currently the first R300000 is tax free at retirement).

To illustrate the effects of the tax, let’s consider an example and assume that Mrs X wants to withdraw the full amount of her preservation fund which is currently sitting at R1.4million.

If she withdraws now (pre-retirement) the following should happen (based on current tax tables):

• The first R22500 will be tax free
• The next R577500 will be taxed at 18% (i.e. R103950)
• The next R300000 will be taxed at 27% (i.e. R81000)
• And the balance will be taxed at 36% (i.e. R180000)
• So she will pay R364950 in tax and will she will leave with R1035050 to do with as she pleases (invest into her bond or into a share portfolio).

Now let’s move forward a few years to her retirement and assume that she has a retirement annuity and/or pension fund with her current employer and that the value has grown to R3million (it is an amount that easily divides by 3). Under current legislation she is entitled to take up to R1million out of the fund and do with it as she pleases. If she had not taken anything from her preservation fund she should get the following:

• The first R300000 would be tax-free
• The next R300000 would be taxed at 18% (R54000)
• The next R300000 at 27% (R81000)
• And the balance of the million would be taxed at 36% (R36000)
• All told she would pay R171000 in tax and she would walk away with R829000 (or she could even limit her withdrawal to the R300000 tax-free and leave the balance in the fund to increase the annuity she receives).

Unfortunately for her, however, she took R1.4million out of her preservation fund prior to retirement and as a result, this amount will be taken into account when the tax is calculated on the 1/3 withdrawal. As a result, anything she takes out of now will be taxed at 36% (the sliding scale is applied after taking into account anything she has already withdrawn from her retirement funds). So if she does withdraw R1million at retirement she would effectively lose R360000 in tax – the entire tax-free portion has been used up prior to retirement and the sliding scale kicked in and is now applied at 36%.

As a result of taking a pre-retirement draw from her funds she effectively forfeits R277500 tax free money (she got R22500 from the pre-retirement withdrawal).

Let’s consider another example where Mr Y takes R300000 out of his preservation fund prior to retirement. His tax calcs will look something like this:

• The first R22500 will be tax free
• The next R277500 will be taxed at 18% (i.e. R49950)
• So he should pay R49950 in tax and should leave with R250050 to do with as he pleases.

Now let’s skip forward a few years to retirement and again assume a pension fund of R3million and that he wants to take out 1/3 as a lump sum. His tax calculations should look something like this:

• The first R300000 (tax-free) has been used up (pre-retirement) and so the sliding scale should kick in immediately with the first R300000 being taxed at 18% (R54000)
• The next R300000 at 27% (R81000)
• And the balance of the million would be taxed at 36% (R144000 – 36% of R400k)
• All told he should pay R279000 in tax and he should walk away with about R721000.

It should be clear from these 2 examples that from a tax point of view it does not pay to make early (pre-retirement) withdrawals from your preservation or pension funds – and we have not even got into what you would have to invest in order to replace the money taken out.

Note: * the above examples are for illustration only and should not be relied upon for advice. You should get a professional tax opinion before making these decisions.

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