The recent changes to Regulation 28 rules around retirement funds has caused a bit of “excitement” in the asset management industry and I have seen at least 2 articles making a case that the stricter enforcement of the Reg 28 rules make Retirement Annuities unattractive investments, especially for younger investors (see the article by Jan Mouton of PSG Asset Management – http://www.psgam.co.za/2011/05/psg-angle-regulation-28-amendments-reduce-attractiveness-effectiveness-for-savers/ ).
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.
