Don’t throw the baby out with the bathwater

The retirement landscape in South Africa is set to undergo major changes as Government addresses the problem of insufficient retirement savings. While the changes will be significant, we need to filter out the noise to determine our clients' real needs and which retirement solution will truly enhance their financial wellness.

Retirement annuities are traditionally a tax efficient manner for wealthy individuals to save for retirement. However, with the tax law changes coming into effect on 1 March 2015, group retirement annuities are gaining popularity with employers as a vehicle to provide retirement benefits for their employees, opposed to traditional pension or provident funds.

Although there is undoubtedly a place for group retirement annuities in certain circumstances, employers and their financial advisers should consider the following points before abandoning pension and provident funds, and in particular umbrella funds.

Membership requirements - group retirement annuities are essentially individual annuity policies administered on a group basis. Most providers have minimum membership requirements, often of five employees, and there is often a minimum contribution amount which can be as high as R1 000 per member. This is different to most umbrella funds where there is either no or lower minimum membership and contribution amount requirements, making umbrella funds more inclusive, specifically for lower contributing employees.

Expenses and commission - the old saying about reading the fine print holds true for fees and the complicated nature of investment fees doesn’t help much either. While the marketing message of no administration fees seems attractive, a fee breakdown must be done to get a comprehensive view.

Let’s consider the fees applicable to a retirement annuity member:

Commission is generally not included in fees quoted and is payable on an “in-out” basis negotiated between the member / employer and the financial adviser. With umbrella funds commission is included in the quoted fees.

Administration fees are still levied when externally managed portfolios are selected and are only waived when an internal portfolio is selected. This is often also the case on umbrella funds.

Even though asset management fees differ between different portfolios, due consideration must be given to ensure that they remain competitive against those offered within umbrella funds. Asset management fees in a retirement annuity can differ by being up to 0.77% higher compared to a similar portfolio in an umbrella fund.

Ease of registration

Umbrella funds allow for ease of registration. Employers can register their staff without having to abide by the Financial Intelligence Centre Act (FICA) requirements. This differs from a retirement annuity where the employer must apply the FICA requirements to every member which is a cumbersome task, especially where employees do not have the necessary documentation and have to get it from a third party.

Insurance benefits

Group retirement annuities do not offer group insurance benefits and would therefore have to be added on a self-standing or unapproved basis. This can have either positive or negative tax implications for members. With umbrella funds, both approved and unapproved are allowed. The employer can choose a structure to optimise the tax efficiency for their members.

Access to money

Members who have retirement annuities do not have access to their benefits before retirement. They can only access their benefits if the amount is below R70 000, on ill-health retirement, on approved emigration or after age 55.

With a pension or provident fund a member has access to their retirement benefit when they leave their employer. This means that a member who has lost their job, for example, due to the employer being liquidated, would not have immediate access to their benefit in a retirement annuity, irrespective of the kind of life crises that the member might experience. This could lead to a member not being able to support themselves and their families when they are not in a position to earn an income while being between jobs. Having said that, South Africans tend to change employers every 3 to 8 years depending on their age and having access to their retirement benefit with an umbrella fund when they withdraw from the fund, should not encourage members to spend their retirement savings on luxuries instead of preserving it when they change employers. It often happens with group retirement annuities that not all members fully understand why they cannot access their retirement benefit from the retirement annuity when changing jobs.

Portability between employers

Portability is often punted as one of the most attractive features of a retirement annuity. Currently a member of a retirement annuity can stay in the same fund when they change employers, unlike with pension and provident funds. This will change from 1 March 2015 when members of pension, provident and preservation funds will be able to transfer between these funds with no tax being paid on the transfer. They will even be able to transfer from a pension or provident fund to a retirement annuity, but not the other way around.

Fund Governance

An umbrella fund’s board of trustees can include independent professional trustees. Trustees are appointed to ensure that the management of the funds is in line with the best interests of members. Umbrella funds encourage employers to establish an advisory body or a management committee, consisting of member and employer representatives, to look after the best interest of the members. The trustees and the advisory bodies play an important role in guiding the investment choices of members that are not financially astute. Under a retirement annuity fund, where there is no employer involvement, members will be required to take full responsibility for their own investment decisions. Some low income earners may find it difficult to understand and make their own investment decisions.

In conclusion, the tax changes due for implementation in March 2015 will certainly have an impact on the South African retirement landscape. While it may make group retirement annuities more attractive for certain schemes, the umbrella fund should not be tossed away as something from the past. Umbrella funds have an important place in the provision of income continuation through insurance and retirement benefits for all employees to help them to enhance their financial wellness.