The impact of Regulation 28 on your retirement funds

Regulation 28 is part of the Pension Funds Act and its purpose is to protect investors against poorly diversified investment portfolios, and ostensibly aims to ensure that investors’ hard-earned money is invested 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 highrisk investments, critics believe that it is unfair to expect long-term investors to dilute their potential returns. 

Regulation 28 applies to pension, provident and retirement annuity funds, and essentially limits asset managers’ allocations of retirements savings to certain assets classes, including equities, property, and foreign assets. As it currently stands, the regulation currently limits equity exposure in retirement funds to 75% whether local or offshore. Further, exposure to local or international property is limited to 25%, while foreign investment exposure is limited to 30%. There are also additional sub limits for alternative investments and the percentage of a portfolio that can be held in offshore, among others. 

Where investors are young and have a long investment horizon, limiting their equity exposure to 75% may appear very restrictive. However, despite these limits, 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.  

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. Before determining that Regulation 28 alone can detrimentally affect your pension, keep in mind that there are other factors that can negatively impact on your investment. Specifically, investment fees and investor behaviour can both impact investment outcomes if not managed carefully. Paying higher investment fees than is necessary will have the effect of eroding your returns over time. Higher fees do not necessarily provide higher returns, and it therefore 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 make it easier for investors to attempt to time markets which, in turn, can be to the overall detriment of the investment. Notably, while discretionary investments provide for better diversification and allow for liquidity, these benefits need to be weighed against the tax implications of investing in a discretionary vehicle versus a compulsory retirement fund. 

On the downside, investing in a Regulation 28 compliant fund means that 70% of your assets 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. This has not been helped by the lacklustre performance of the JSE over the past few years – although having said that, it is dangerous to make the assumption that global economies will always deliver superior returns. In addition, it is important to keep in mind that JSE listed companies generate over 50% of their profits from overseas which means that investors are effectively 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, this 70% asset allocation can make some investors uneasy. It also means that investors can allocate only 30% of their portfolio towards global industries, many of which include technologies and innovations that do not have local equivalents. Given the impact of Covid-19, load shedding, corruption and mass unemployment, now is an opportune time from an investment perspective to have more global weighting in one’s portfolios so as to protect against further deterioration of our local economy, although this will naturally not be possible in a retirement fund structure. Having said that, investors should keep in mind that retirement funds are not the only vehicles that can be used to house savings earmarked for retirement, and investors can make use of discretionary investment structures to achieve global diversification in their portfolios. Further, while global markets have out-performed the JSE over the past few years, it’s not to say that offshore investments will always provide better returns. 

Critics of Regulation 28 regularly advise investors to retire from their retirement funds as soon as possible, and to invest in discretionary funds. Before doing so, however, it is highly advisable to obtain professional advice as there is a fine balancing act to be achieved between minimising tax, optimising investment returns, ensuring future liquidity and managing risk. 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 discretionary portfolio has never been easier. Just as it makes sense to diversify one’s investment portfolio, so too should we diversify the vehicles we use to achieve our wealth creation goals. 

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