Treasury’s new Default Regulations for retirement funds, unpacked
In recent years National Treasury has been active in driving various retirement reform initiatives with the objective of ensuring a better outcome for South Africans during retirement. The first material change in legislation involved the Taxation Laws Amendment Act of 2015, which passed some of Government’s retirement reform proposals into law. These retirement fund rules were designed to harmonise the tax treatment for all types of retirement funds - pension, provident and retirement annuity funds - and took effect on 1 March 2016.
The latest initiative being implemented by National Treasury relates to the requirement for all South African retirement funds to introduce default investment strategies. Default Regulations came into effect on 1st September 2017, with implementation from 1st March 2019 for all retirement funds registered before 1st March 2018. The regulations were introduced to ensure the protection, preservation and consolidation of retirement benefits as well as the sustainability of post-retirement benefits paid to fund members.
What are Default Regulations exactly?
Regulations 37, 38 and 39 require that retirement funds make appropriate default investment options available to members and that all related fees and charges are simple to understand, reasonable, transparent and competitive, considering the nature of the portfolios. Investment portfolio design must also consider both active and passive investment strategies and members will be allowed to opt out of default portfolios. The default portfolios and investment strategies will need to be reviewed by retirement funds on an ongoing basis.
Given that most retirement funds already apply a life stage model consisting of a series of pre-selected portfolios, the impact on retirement funds and their members will be limited from a pre-retirement perspective. Retirement funds are also required to make available a default annuity option at retirement.
It is expected that most funds will opt for both a default living annuity and a default conventional life annuity option in order to cater for the needs and preferences of all its members. Members will have to actively “opt in” to the default annuity option offered by the fund. The default annuity option might be an “in fund” or “out of fund” annuity solution depending on the investment platform offering available to the fund and the default strategy(ies) that the fund chooses.
Option: Living Annuity
Where a member chooses a living annuity as their retirement income solution the default investment strategy of the fund should allow the member to remain invested in the default portfolios that they were invested in, pre-retirement. This will allow fund members to experience a seamless transfer from pre- to post-retirement as they will not have to fundamentally change their portfolios or have to select new investment strategies. The institutional pricing available under a default annuity will, in most cases, also result in the member avoiding the more expensive retail pricing offered as part of a third party annuity option. Members will also be able to avoid any market timing risk as the fund will be able to do a unit transfer of their investment portfolio to the fund’s default living annuity without having to sell out of the market and then re-enter the investment market.
Option: Life Annuity
For life annuity options the retirement fund can choose to make available a preferred range of life company options that caters for options such as a single or joint life annuity with a fixed income, escalating income or inflation linked income option as well as spouse and children’s benefit options. Quotes can be obtained at retirement for the members to consider. Should a fund member not select the client’s default options they may invest their retirement benefits in any third party living annuity and/or life annuity of their choice.
Major differences between a life annuity and a living annuity
A life annuity is ‘bought’ from a life insurance company and the income received is
determined by the life company at a fixed rate for the duration of the annuity. The
annuity terminates at the death of the recipient or the surviving spouse, depending
on the specific option taken and no capital is preserved.
In case of a living annuity, the recipient gets to choose the rate at which a monthly
withdrawal is made (between 2,5% - 17,5%) and the capital can be transferred to
beneficiaries (next of kin) in case of death.
A fund member is allowed to move their retirement savings from a living annuity to a life annuity during retirement, but not vice versa.
Retirement funds are also expected to make financial councillors available that can assist fund members in determining if a living and/or life annuity would be the most suitable retirement income solution and to assist members in selecting the most appropriate product solution.