What does Regulation 28 mean for my retirement savings
Regulation 28 is a part of the Pension Funds Act and its purpose is to protect investors against poorly diversified and poorly constructed investment portfolios. It aims to ensure that investors’ hard-earned money is invested in a sensible way without too much exposure to risky assets, for the main purpose of building up a substantial pot for retirement. While proponents of Regulation 28 believe that this piece of legislation is effective in protecting pension fund money from high-risk investments, critics believe that it is unfair to expect long-term investors to dilute their potential returns.
Regulation 28 applies to all retirement funding vehicles, such as pension, provident and retirement annuity funds. It 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 the following:
– Equities (local and offshore) – 75%
– Local or international property – 25%
– Foreign investment – 30%
There are also additional sub-limits for alternative investments and the percentage of a portfolio that can be held 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 who are SA tax residents. 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.
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 poor performance of the JSE over the past few years. 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.
A further concern for investors revolves around the exposure to equities as an asset class. As an asset class, equities tend to be high risk/high reward by nature. A common strategy is to invest more in equities when you are younger, then shift to a more balanced and then conservative portfolio as you approach retirement age.
Historically, equities as an asset class generate the highest returns over time. An effective way to diversify the risk of having a high equity-based portfolio is to ensure you are invested over a long period of time as generally, time tends to diversify and erode the risk of equities. Therefore, whilst you are younger, you have years ahead of you to make up for any potential losses.
By limiting equity exposure in your portfolio to 75%, those investors with higher risk profiles or who have longer investment terms to retirement are limited in terms of the potential growth of their portfolios.
Critics of Regulation 28 regularly advise investors to retire from their retirement funds as soon as possible and to invest in discretionary funds.
As expats living abroad, your tax status, as well as long term objectives such as where you will ultimately retire, must be factored into your retirement planning. Before making any decision as to whether or not you should retire from SA retirement funds or retain them, it is highly advisable to obtain professional advice. Whilst the main goals of most investors are to minimize tax, optimize investment returns, ensure future liquidity and manage risk, there are many factors that need to be considered. All these factors require a financial professional to assess the overall circumstance and provide a holistic solution, incorporating all the factors above.
About Mike Coady
Mike Coady is an expat expert based in Dubai and is on hand to help with all of the above and more.
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Blog published by Mike Coady.