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12 Mar 2010

Retirement Annuities - The Iceman Cometh

Darron West, Foord Asset Management
 
Recently released draft changes to Regulation 28 of the Pension Funds Act (which govern how the underlying assets of a retirement fund may be invested) are likely to make retirement annuities (“RA’s”) less beneficial for investors.  RA’s have long been considered an astute choice of product for providing for one’s retirement.  But for many, a discretionary direct investment in unit trusts (more accurately called collective investment schemes) may now be more advantageous.
 
So-called “third generation” RA products are today much more transparent and cost-effective than traditional life insurance based RA’s and have been hailed as the panacea of investment products, especially of late with changes to estate duties and emigration laws.  Typically, RA’s have been favoured by investors with higher incomes who have sought to use the tax deductibility of contributions to RA’s to lower their immediate tax burden.  
 
Third generation RA’s are offered by a variety of platforms which have allowed considerable client discretion in selection of the underlying investment exposures.  However, this will soon change as the amendments to Regulation 28 which stipulate that each member will be required to maintain prudential exposures rather than exposures more aptly suited to their risk profile and time horizons.  For example, RA investors with 30 year time horizons will no longer able take pure equity exposures but must be law invest in a prudential balanced fund.
 
The purport of Regulation 28 has always been (and continues to be) to provide prudential guidelines for the investment of the assets of a retirement fund as a whole.  The rationale is that without such regulations, investment managers may invest the assets inappropriately or injudiciously, thereby prejudicing the investors.
 
The pretext of the proposed amendments is to update definitions and to take account of modern developments in the financial markets.  However it also now requires that where a fund provides an individual member with an option to elect his or her underlying investment exposures “and that member is directly exposed to the return on the elected investments, the underlying investments must now comply with Regulation 28 and its spreading requirements.”   This restriction may ultimately render the RA a fundamentally less desirable product – especially for high net worth individuals who have often sought pure equity or pure offshore exposures within their third generation RA product.
 
With that said, there may still be some who argue in favour of the RA based purely on the apparent tax benefits inherent in these products.  Our detailed and comprehensive testing of these perceived benefits yields quite different conclusions, which are the subject of a later article.  In the mean time, investors should be aware that the RA is not necessarily a retirement funding panacea, and the prospect of well-intentioned, but more restrictive, investment guidelines amplifies this notion.
 
We continue to argue that disciplined investors are better off investing their after-tax retirement savings directly into discretionary unit trusts where they will continue to have the freedom to invest according to their own risk profile and time horizons.  The proposed revisions to Regulation 28 likely to take effect later in the year make that argument increasingly compelling.

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