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Retirement reforms will change the face of retirement strategies

20 April 2015 Jonathan Faurie

The Battle of Agincourt was one of the defining battles in the Hundred Years War between England and France. It was renowned for its change in battle tactics by Henry V of England where he chose not to use hand-to-hand combat, but rather his archers to win the battle.

While we would like to think that retirement is a time of peace and tranquillity, we must be realistic, it can be a battle if the wrong strategy is selected leading up to retirement. While this has always been the case, the threat is being exacerbated by the fact that retirement reforms will change the face of retirement strategies as we know it.

Be aware of the new rules

While many of the proposed Retirement Reform changes will only be implemented next year, a change – which has been in effect since March - disallows lump sum withdrawals from Provident Funds, instead requiring them to be annuitised in the same way as Pension Funds. Please note that the implementation of these retirement reforms has been delayed, possibly to 1 March 2016 or 1 March 2017.  References to "1 March 2015′ refer to the actual implementation date.

Sharon Möller, Financial Planning Coach at Old Mutual Wealth, says one of the biggest current myths is that this change will somehow disadvantage Provident Fund members.

“The changes are actually an incentive for people to save more for their retirement and preserve their wealth. Applying a limit to the amount that can be taken as a lump sum is intended to help protect the capital,” says Möller.

Research has shown that when clients are allowed to draw their money as a lumpsum, they tend to spend it on luxuries and reducing debt. By forcing an annuitisation, it is encouraging saving and is forcing people to rethink their strategies when it comes to reducing debt early in their working career. The role of the adviser is imperative here as a well thought out financial plan, which includes intense budgeting, can assist in this rethink.

Make the right decision

Over the past few years, Provident Funds have become more popular than Pension Funds for the simple reason that there is a lumpsum payout, which is more flexible than a monthly pension payout. The problem came in where the majority of people on Provident Funds did not allocate a portion of their funds towards purchasing a conventional annuity.

In terms of the changed legislation, Provident Fund contributions, accumulated after March this year, will be restricted to only one third being taken out as a lump sum. The remainder will need to be invested to provide a monthly pension payout. The change only applies to those who are under 55. Older members will still be able to withdraw the accumulated funds as a lump sum when they retire. With this new law, it becomes a much of a muchness for younger members.

“When the tax changes are implemented, the tax treatment of all retirement vehicles will be aligned. Furthermore, employer contributions to retirement funds will be taxed as fringe benefits in the hands of employees. The changes will also allow a tax deduction of up to 27.5% of the total remuneration relating to contributions to pension, provident and retirement annuity funds, subject to an annual cap of R350 000. The deduction allowed is currently significantly lower,” says Möller.

Who wants to live forever?

The first German Chancellor, Otto von Bismark, was one of the first statesmen to introduce the concept of retirement. According to his thinking, the ideal retirement age was 65; however, it is important to point out that workers in those years generally didn’t live past 40.

Since then, different types of jobs, advances in medicine and healthier lifestyles have seen life expectancy increase dramatically. In the days of Von Bismark, it was inevitable that you would not outlive your pension funding. However, it is a struggle today to make your money last when your savings pot only caters for an age which you most likely will outlive.

“We are in an era where life expectancy of 100 years has become a realistic duration to plan for. Furthermore, expenses often rise in retirement, with more leisure time and activities such as holidays, eating out and expensive hobbies,” says Möller.

She adds that it is important to be realistic in terms of how much clients can draw each month.  Möller feels that not drawing more than 4 to 5% during retirement is adequate as it will provide a low risk path and will allow clients to invest the remainder of their funds to deliver returns which at least exceed the annual inflation rate.

Keep an eye on the market

While this is mainly the realm of fund managers, advisers do have a role to play in this as they need to focus their planning around balanced or passive funds as opposed to active funds in case the market suddenly changes. And in the current economic climate, this is a possibility.

Rezco Asset Management Chief Investment Officer, Rob Spanjaard points out that the bull market has been going for over six years and investment managers now need to moderate their risk in anticipation of a potential bear market on the horizon.

“We are worried about the bull market. Clients have become used to enjoying returns of as much as 20% and the reality is that while the market keeps getting higher, it is now expensively priced,” says Spanjaard.

He adds that this is in effect not so much a bull market, but could be seen as a pig market because the trouble is that the market could still double from here – or it could halve. The real question facing investors right now is what assets to own and when to leave.

Editor’s Thoughts:
It’s not that retirement has become a challenge in South Africa, it is that a comfortable retirement has become a challenge. As advisers, we need to align our thinking with governments vision   and we need to make people aware of challenges such as increased standard of living and cost pressures so that they can make the right short-term sacrifices for the eventual long-term gain. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts jonathan@fanews.co.za.

Comments

Added by Gavin, 20 Apr 2015
Thomas it seems that nobody learned you to spoke English proper or you can't be bothered to check your post before hitting the send button.
It has been proven by people cleverer than me that the RA is the most efficient method to SAVE FOR RETIREMENT. Google Prof Matthew Lester and get educated
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Added by thomas, 20 Apr 2015
Retirement provision in SA has become a real challenge as you rightly observed and noted. Over the years retirement funds has changed (rules) to a extent where it has become nearly impossible to plan at all as the rule makers can chop and change as they seem fit. A huge attraction benefit associated with retirement funds are the tax benefit. A benefit is derived on current contributions and once the fund mature the owner is taxed until the day he /she die on the income of course. My humble opinion regarding the implementation of forced 2 thirds as a so called annuity income is firstly a way for the SA govt to ensure that funds cannot be moved outside Sa borders and will ensure secondly a nice income stream of tax that will continue until the death of the owners and spouses. Furthermore will the owners of such pension funds be totally at the mercy of the legislation makers regarding new rules and tax implications. Without being overly negative I must be realistic regarding the future of South Africa (economically and politically) and the value of the rand(exchange rate) in the future as well as the inflation rate. After considering all of this it is my opinion that it is of the utmost importance and probably as viable to rather invest in unit trusts or other liquid investments that can be moved at short notice. I am of opinion that as a example unit trusts will be over time be a better investment despite the fact that there are no tax benefit as far as deductibility is concerned(CGT and so on). A tax benefit means nothing if your money are worthless. I say this in the light of our current political situation, strikes, power supply or rather lack thereof , corruption, BEE, Zenofobia and a clueless leadership corps. I think it is imperative to invest 40% (of savings)plus abroad and this is rather difficult with the current pension rules/regime. Most successful listed companies are slowly but surely moving their business head offices and other operations to other countries and this should be a good clue.
So..despite the lure of the tax benefit (deductibility of pension contributions) I am of opinion that the exchange rate and growth over time in offshore investments will probably outweigh the tax benefit.
The new 27.5% deductibility rule is probably a further lure of govt to ensure that more funds are secured to stay in SA forever. Maybe I am wrong..time will tell.

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Added by Common Sense, 20 Apr 2015
I withdrew 100% of my provident fund and paid off all my debt
BUT THEN (there is always a BUT)
I kept on investing the previous debt payment and today I'm in a much better NAV (net asset value) than I would have been if I did not do it this way for the following reasons
(1) without debt the full payment works for you instead of a lot of interest working for the debtor (2) I get better growth if I'm not under the pension fund law.

Three friends of mine did the same with the same result in the end.
It boils down to discipline!
If you don't have it, see that you get it!
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