By Nick de Villiers, Trust Officer, Personal Trust Noordhoek
There has been much discussion in the Press about potential changes to legislation governing pension funds and retirement funds and how they may invest. Government has been mulling changes to Regulation 28 of the Pension Funds Act which governs all pension, provident, pension and provident preservation funds and retirement annuities. The suggested changes are aimed at forcing these funds to invest a certain percentage in either government bonds, or government projects. It is not yet certain what the exact nature of these changes will be.
Many of you may remember the legislation in the 1980s compelling pension funds to hold a certain percentage of their assets in government bonds, effectively serving as an additional tax and reducing fund returns. There is already criticism levelled at Regulation 28 because it prescribes that no more than 30% of assets in the fund may be invested offshore. It also places a limit on how much may be invested in equities – a maximum of 75% of the fund’s assets.
This article will deal with a specific aspect of Regulation 28 and that is the 30% offshore limit. Personal Trust’s investment risk matrix suggests that between 30% and 50% of your assets be invested offshore. People who have family overseas or who wish to travel frequently may want to have more than this offshore to hedge against further Rand weakness. While many have the means to do this using their discretionary cash (non-retirement funding money), most people do not have the funds to make up the shortfall in offshore investments using spare change they may have found behind the couch. There is a solution to this problem, but it is only available to those who are 55 years old or older.
We will not discuss here the benefits and risks of offshore investing – that would be a more appropriate discussion to have with your trust officer should you be interested in investing offshore.
At retirement (from the age of 55 or older) retirees may take a one-third lump sum in cash from their pension or retirement annuity. This would be tax-free if it is not more than R500,000 and they have not taken any previous lump sums. The remaining two-thirds of the pension / retirement funds must be used to purchase an annuity.
The traditional guaranteed life annuity offered by Life Insurance companies invests this capital on behalf of the investor and pays a fixed monthly pension or allows for an inflationary escalation for the life of the annuitant. On the death of the annuitant some pay a lesser amount to the annuitant’s spouse. Once the spouse dies heirs cannot inherit whatever capital may be left. Investors also have no say over the initial income taken and no flexibility to make changes once they purchase the product.
In recognition of some of the drawbacks of guaranteed annuities, most specifically that capital could not be inherited by heirs after the death of the last spouse, living annuities were created.
There are two main forms of Living annuity:
- In-Fund – this refers to an annuity that is housed within an existing pension / provident fund. These are typically institutional pension funds or government pension funds. These usually have lower costs, but you are limited to four funds. These funds are subject to the Pension Funds Act and Section 37C applies. This (Sec 37C) governs the distribution and payment of lump sum benefits payable on the death of a member of a pension fund, provident fund, pension and provident preservation fund and retirement annuity fund. These benefits are colloquially known as “death benefits”.
- Out-of-Fund – this refers to a separate annuity product not contained within the retiree’s existing pension fund. You may invest in an unlimited number of funds and most importantly you are governed by the Long-Term Insurance Act, not the Pension Funds Act. This means that you are not subject to Regulation 28.
Many people may not be aware that an ‘In-Fund’ Living annuity is still governed by the Pension Funds Act as the funds are housed within the institutional or government pension fund. Therefore, they must comply with Regulation 28, and section 37C applies.
Astute readers may now see the solution to avoiding Regulation 28. The way to invest more than 30% of your retirement funds offshore is to purchase an ‘Out-of-Fund’ Living Annuity (you would need to be 55 or older to take advantage of this). This allows the investor control over how the underlying funds are invested (you may invest 100% offshore in a domestically domiciled feeder fund) and the funds are not subject to any section of the Pension Funds Act.
Personal Trust offers clients the option of purchasing an ‘Out-of-Fund’ Living annuity from select service providers and we can also assist in the management of the underlying assets. Talk to your Trust Officer about an ‘Out-of-Fund’ Living annuity to see how avoiding the terms of the Pension Fund Act may benefit your retirement investments.