Dear reader

In this newsletter we discuss a number of highly relevant topics that should warrant your attention and discussion at board level. There is an unfortunate tendency in our industry to change for the sake of changing without questioning whether the change is appropriate for a group arrangement intended to serve the needs of the group as a whole rather than only a few individuals.

On the topic of the sovereign debt crisis, as laymen we are concerned about the consequences of the huge debts that countries took up in order to stimulate their economies out of the crisis. It is difficult to envisage how countries will reduce their debt levels without raising taxes thereby retarding economic growth. Another plausible way out could be the creation of inflation in an effort to inflate asset values while at the same time keeping interest rates well below inflation so that debt declines in real terms.

We hope that you find this newsletter interesting reading, once again. And please feel free to comment: tell us what you value and how we can improve the content.

Regards

Tilman Friedrich

Tilman Friedrich's Industry Forum

BENCHTEST MONTHLY 05.2010

In May, the average prudential balanced portfolio returned a meager minus 3.1% (April 0.68%). Best and worst performance for the month was delivered by Allan Gray (minus 0.72%) and Prudential (minus 4.35%), respectively. We believe that the global economy is now at the cross roads. It can either turn flat to negative, or it can pick up steam again to mirror a situation we have experienced up until the financial crisis of late 2007. For more info and our views, click here...

IN THE PICTURE

We're better at pension investments than we are at predicting football outcomes : Members of the RFS team came out in support of Bafana Bafana. On the bright side, vuvuzelas have been banned from the office.

PENSION OR PROVIDENT FUND, LUMP SUMS OR PENSIONS – WHERE TO FROM HERE?

Why might my capital be insufficient to retire?

As we will show in our next newsletter, making adequate provision to retire with dignity is not so easy to achieve in the first instance. It requires adequate funding by employer and employee throughout the employee’s working life, it requires that not too much but also not too little of the contributions be diverted for other purposes and benefits, and that the capital accumulating for retirement does not experience any leakages.

The following are typical pitfalls that will prevent you from achieving this ideal:

• early withdrawal of accumulated capital,
• poor investment returns,
• high management costs,
• too low a basis for setting a contribution rate, and
• too low a contribution rate.

Government needs to take measures to prevent leakages

At the recent RFIN breakfast seminar reported on below, the Ministry of Finance expressed its concerns how to ensure that government doesn't end up bearing the responsibility for persons that have made inadequate provision for their retirement.

We have on various occasions in the past dwelled on the topic of the proposed National Pension Fund, one policy measure government is considering in order to ascertain that all citizens will eventually have provided adequately, to retire with dignity. Clearly there is serious and justified consideration how to go about this national objective. And it does not take much gray matter to appreciate that the approach must be two-pronged, one being to ascertain that everyone contributes adequately, the second one being to plug the holes in the system that cause leakages.

The RFIN breakfast session dealt with the topic of preservation of retirement capital upon resignation. Currently, there is no legal requirement to preserve one’s capital upon resignation. The Income Tax Act encourages preservation by allowing retirement capital to be transferred to another approved fund, tax free but at the same time it allows you to withdraw a portion or all your capital within the first three years of resignation. This is only one leakage. The National Pension Fund envisages compulsory preservation but it is not in force.

A much more serious leakage is the provision for provident funds in the Income Tax Act. These funds cannot pay pensions but only lump sums and oblige the employee to accept cash as the default arrangement. Obviously most employees are unlikely to reinvest the cash once in their possession. We question the existence of provident funds.

Another serious leakage is caused as the result of the Income Tax Act not prohibiting pension funds to pay death benefits and disability benefits as lump sums and on top of it, ‘creaming’ off income tax on such lump sum benefits. So even if the employee/dependant wants to reinvest the capital, a portion will be given up in income tax.

There are other less serious leakages which we will not cover now. The most serious leakages can and should be addressed by government through policy measures. The thought has been raised for the Income Tax Act to do away with provident funds. It is also likely that the larger portion of any benefit to be offered has to be an income benefit with only a smaller portion in form of a lump sum. With regard to the National Pension Fund, it is still being contemplated whether or not any exemption will be granted to existing funds. It would appear likely that if any exemption were to be granted, it would be on the basis that employee and employer contribute rate towards the fund is at least equal to that of the National Pension Fund (12%-14% of payroll?) and that benefits will primarily take the form of income rather than lump sum benefits.

Trustees need to look at their fund benefit structure

Often pension funds require the retiree to purchase a pension from another fund or insurer. Such transactions not only often expose the retiree to unscrupulous operators, but the retiree will incur substantial costs. Trustees are also often overwhelmed by consultants talking them into unnecessarily complex structures that might serve the needs of a very small minority but come at a cost. Trustees often do not grasp the complexity of such structures nor do they appreciate the risks and the costs attaching to such complexity. The consultants often introduce such arrangements with their own agenda, such as selling their house products and services and making themselves indispensable for the fund.

Trustees of course are free to pre-empt legislative measures to plug these leakages that are likely to be addressed through government policy measure sooner or later. In this light, here is sound advice to employers until such time as the future of the National Pension Fund and of the Income Tax Act with regard to retirement provision has been cleared:

• Rather offer a pension fund than a provident fund.
• The pension fund should offer income benefits rather than lump sums in the event of death, disablement and, as a matter of course, in the event of retirement.
• Be wary of converting your fund from pension fund to provident fund and to do away with income benefits.
• Be wary of outsourcing pensioners if your fund is large enough to carry the liability for in service spouse’s and children’s pensions and post retirement pensioners.
• Be wary of dissolving your investment reserve which is particularly useful for funds maintaining a pensioner pool.
• Be wary of unnecessarily complex and expensive fund structures that may serve a small group of members only.

Once abandoned, it will be extremely difficult for any fund to reintroduce the previous arrangements.

WILL PRESERVATION BECOME COMPULSORY?

RFIN recently hosted a breakfast seminar at Hotel Thule on preservation of retirement capital. Deputy Minister of Finance, Kalle Schlettwein delegated a senior official to speak on behalf of his ministry. His message in short was that the Ministry of Finance is seriously concerned about the attrition of retirement capital through withdrawal of capital upon resignation. He indicated that a working group will be established to look at this matter and invited the private sector to participate and to contribute.

INTERESTING MEDIA SNIPPETS
Things to think about, contributed by Stefanus Morris

The Essence of Character
(Accountancy SA, May 2010)

Recent incidents of businessmen lured by riches and abundance into mismanaging investors’ money have put question marks on the character of such individuals and lead us in turn, to question ethical leadership and to try and define the essence of good character. The May 2010 issue of Accountancy SA identified nine aspects which produce the essence of character…

Are you comfortable with your trust deed?
(Money Marketing, April 2010)

Are you one of those people who would rather get a standard template of a trust deed and fill in the blanks or do you prefer to take care when establishing one? If you have been thinking of setting up a trust deed or simply been having problems understanding your current trust deed, here are some pitfalls to watch out for and good advice when establishing a trust as Karen Coetzer of BJM Financial Services Group explains in this article…

The “One Stop Shop” - is it really more cost effective?
(Pensions World, March 2010)

When it comes to retirement fund management, is it really more cost effective to “put all your eggs in one basket”? Rob MacMahon takes a closer look at the ”one stop shop” type of pension service providers to see if it provides “easy”, effective and transparent governance in this article…

Gunter Pfeifer's Benchmark Notes

UMBRELLA FUNDS OFFER ECONOMIES OF SCALE

The size of a fund determines the economies of scale that can be realized. This is as the result of the fact that every fund incurs fixed costs that are not dependent on size, and variable costs based on size. The fixed costs have to be shared by all fund members and will obviously be proportionately higher for smaller funds than they would be for larger funds.

There is a cut-off point below which it is not viable to maintain a fund as an independent entity. This cut-off point depends on a number of variables. However, as a rule of thumb, it can be shown that total direct fund management costs should not exceed 15% of contributions to the fund. From that point, it becomes more cost effective to forego the tax benefit and to invest the contributions directly rather than via a fund. Having said this, we have pointed out above that pension funds are often an employment imperative and also offer other benefits such as legal protection from creditors, competitive group risk and other benefits.

Fund management costs and reinsurance premiums may consume a significant portion of contributions and trustees need to remain vigilant to ensure that the cost-benefit ratio is optimized. Quoting Dawie de Villiers, CEO: Sanlam Structured Solutions, it becomes evident that saving 0.5% in costs to increase retirement contributions adds 1 year to your retirement capital (based on 35 years of contributions). While that may not sound onerous, Trustees should consider all options to improve the cost-efficiency of their retirement funding arrangement. Umbrella fund arrangements can for example offer substantial economies of scale that smaller funds will be unable to match. A hypothetical fund with 150 members and a payroll of about N$20 million per annum, suggests that the total management costs could easily consume 10% to 15% of contributions. In an umbrella arrangement these costs could easily be 40% lower.

While each fund, including the umbrella fund, needs to appoint an auditor and an actuary, the umbrella arrangement caters for a number of employers and individuals under one legal entity and therefore can economize. This is true for all overhead fixed costs in fact. In the example quoted, the private fund costs do not cater for investment surveys, asset consulting, NAMFISA levies or trustee training, while these services are included in the costs charged by the Benchmark Retirement Fund.

Another major cost element that has not been quantified is the time spent by trustees to prepare for and to attend trustee meetings. In addition, the trustees carry the risk for the decisions they take. As for the auditor and the actuary, each retirement fund requires a board of trustees. For private funds the trustees are normally appointed by the employer and by the employees. The trustees of an umbrella fund are normally appointed by the sponsor and these may include independent trustees. It therefore allows the participating employer in an umbrella fund to focus on running the business while the board of trustees manages the retirement fund. Due to a bigger pool, an umbrella fund can often afford to appoint trustees with the required skills and experience.

Charlotte Drayer's Administration Forum

RETIREMENT BENEFITS FROM A FIXED CONTRIBUTION TYPE PROVIDENT FUND

In terms of the Income Tax Act a retirement benefit from a provident fund can be paid as follows:

1. Full encashment: The member can take his/her full share capital as a cash sum. Currently 2/3 of this cash sum is taxable and 1/3 is tax free.

2. Partial encashment with purchase of a pension: The member can opt to take a portion in cash and to apply the balance to purchase a pension from another approved fund. Any portion that is transferred to such other approved fund will be transferred tax-free but the resulting pension is taxable. Any portion that is taken in cash is currently tax free up to an amount not exceeding 1/3 of the member’s retirement capital, the balance is taxable.

3. Full pension purchase: The member’s total retirement capital can be applied to purchase a pension from another approved fund. In this case the total pension is taxable.

Provident funds do not allow members to arrange a pension from the fund. If a member chooses to arrange a pension, the retirement capital must be transferred to another approved fund providing pensions e.g. a retirement annuity fund or a fund like the Benchmark Retirement Fund.

Note:

• Purchasing a life annuity from an approved retirement annuity fund: insurance companies usually accept only the full retirement capital (three thirds) and will pay out the one third cash commutation themselves. If the provident fund from where the member retired has already paid out one third, the member/his broker has to ensure that the insurance company will accept the two thirds balance of the member’s retirement capital.
• Insurance companies also offer immediate- and living annuities that are pure insurance products and not an approved fund. These products do not allow any cash commutation. Any cash commutation therefore has to be paid by the provident fund providing the retirement benefit. We are of the opinion that a transfer from a provident fund for the purpose of arranging an annuity from such an insurance product is not tax-free. Although the Receiver of Revenue is currently issuing nil tax directives for such transfers, we believe that members who entered into such arrangement may at some time in future be faced with a tax claim in respect of the capital that was transferred.

It is important to be informed whether the fund providing the retirement benefits is a pension fund or a provident fund as benefits are taxed differently. One should be aware of the options available and give clear instructions as to how the retirement benefit has to be provided by the provident fund.