Regulation 28 of the Pension Funds Act: Your questions answered

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Controversial as this piece of legislation may be, Regulation 28 needs to be fully understood in the broad context of one’s overall investment portfolio without succumbing to fearmongering, greed, or emotional biases. In this article, we answer the most frequently asked questions in relation to Regulation 28.

What is Regulation 28?

Part of the Pension Funds Act, Regulation 28 is designed to protect investors against poorly diversified investment portfolios by ensuring that pre-retirees invest their hard-earned money in a sensible way without too much exposure to risky assets. While proponents of Regulation 28 believe that this piece of legislation is effective in protecting pension fund money from high-risk investments, some critics believe that it is unfair to expect long-term investors to dilute their potential returns. That said, the recent changes to Regulation 28 have seen the relaxation of certain limits and have created greater flexibility for retirement fund investors.

What is an approved retirement fund?

Regulation 28 applies to approved retirement funds including pension, provident, preservation, and retirement annuity funds, and essentially limits asset managers’ allocations of retirement savings to certain asset classes, including equities, property, and foreign assets. For the sake of clarity, note that an approved retirement fund refers to a fund that has been approved by SARS in terms of the Income Tax Act in respect of which a member meets the eligibility requirements for admission to the fund.

What are the current limits?

A notable amendment to Regulation 28 has raised the aggregate exposure to foreign assets in an approved fund to 45%, which refers to the aggregate of all applicable investments outside of South Africa. With retirement fund investors now able to invest up to 45% of their portfolio in offshore assets, asset managers are able to create more diversity in their portfolios by seeking investment opportunities in companies, industries, and sectors not available in South Africa. Other limits include 75% in equities, both local and foreign, 25% in property, 15% exposure in private equity, 10% in commodities, 10% in hedge funds, and other excluded assets of 2.5%. Further, retirement funds may not invest more than 25% across all asset classes in one particular entity or company. Despite these limits, however, retirement annuities continue to provide tax-efficient investment opportunities for investors. This is because individuals are permitted to save up to 27.5% of the greater of their taxable income or remuneration each year, with an annual maximum of R350 000, which has the effect of significantly reducing their tax liability. In addition, retirement annuities are exempt from tax on dividends and interest, and no capital gains tax is paid on investment growth. At the end of the tax year, investors can include their RA contributions on their tax return forms and claim a deduction from SARS.

What about cryptocurrencies?

The amendments to Regulation 28 clearly prohibit investment in cryptocurrencies as a result of the volatile nature of these investments as well as the lack of industry regulation. Remember, retirement fund trustees have a fiduciary duty towards the fund and its members, and exposing retirement fund assets to cryptocurrencies is not deemed to be in the best interests of the fund members.

What are the disadvantages of Regulation 28?

Although the offshore limit has been increased to 45%, the reality is that 55% of your retirement fund capital must be invested in South African assets which, given the rate at which the number of listed companies on the JSE has shrunk over the past few years, means that investors have limited choice when it comes to investing in local companies. Having said that, one should not lose sight of the fact that JSE-listed companies generate over 50% of their earnings from overseas which means that retirement fund investors are getting exposure to foreign economics through their local investments.

Given that South African shares can be particularly volatile in the short term due to currency fluctuations, as well as the ongoing political and economic issues within the country, the 55% local asset allocation can make some investors uneasy. It also means that investors can allocate only 45% of their portfolio toward global industries, many of which include technologies and innovations that do not have local equivalents.

What is meant by the grandfather clause?

Prior to April 2011, assets were managed in accordance with Regulation 28 at fund level which meant that individual retirement fund members were not required to comply with Regulation 28 provided that the collective fund was in compliance. Since April 2011, all new retirement investments are required to adhere to the provisions of Regulation 28 at individual level, while all individual members who invested prior to this date are exempt provided that no transactional changes are made to the portfolio. These pre-April 2011 investments retain what is referred to as ‘grandfathered’ status and do not need to be Regulation 28 compliant. However, should the member make any changes to her debit order, make ad hoc contributions or perform any switches in the portfolio, the ‘grandfathered’ status will fall away and the individual will need to make her investment Regulation 28 compliant,

So, should I keep my money housed in my retirement fund?

Many critics of Regulation 28 encourage investors to cash in their pensions as soon as possible or resign from their retirement funds as early as possible so as to move their money into more diversified portfolios with greater offshore exposure. However, there are significant tax implications when retiring and/or withdrawing money from a retirement fund, and doing so should not be a knee-jerk reaction to the restrictions of Regulation 28, keeping in mind that there are several other factors such as investment fees and investor behaviour that can negatively impact on your investment.  Remember, higher fees do not necessarily provide higher returns and it makes no sense to compromise your returns by paying too much for investment management, administration, and/or advice. When it comes to investment behaviour, investing in a retirement annuity is a great way to enforce disciplined savings as you are not permitted to access your capital before your reach age 55. Once committed to an investment strategy in a compulsory fund, investors are more likely to stick to the strategy over the longer term which bodes well for investment returns. On the other hand, the flexibility provided by discretionary investment vehicles makes it easier for investors to attempt to time markets which, in turn, can be to the overall detriment of the investment. While discretionary investments provide for better diversification and can create liquidity in your retirement years, such benefits need to be weighed against the tax implications of investing in a discretionary vehicle versus a compulsory retirement fund.

The fact remains that South African investors have a wide range of discretionary and compulsory funds to choose from when building their portfolios, and incorporating global diversification into one’s portfolios has never been easier. Finding the balance between minimising tax, optimising investment returns, ensuring future liquidity and managing risk can be difficult to achieve so, before making any knee-jerk decisions regarding your retirement fund investments, we recommend seeking professional, independent advice.

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