NFB FINANCIAL UPDATE Volume54 Feb 2011
FROM THE CEO’s DESK
W
hilst the developed world wrestles with unemployment, credit freezes, disheartened consumers - the list goes on - we in the so-called Emerging Markets (note the capital letters) are pressing on regardless. Growth rates astound in certain geographies and when the developed basket cases resurface, it appears that this will only serve to further underpin the results from yesterday's minions. Xmas 2010 was preceded, notably even in S.A., by some biggish Special Offers, otherwise known as Big Discount Sales. Whilst all of this has been going on in the towns and cities, the share prices of the markets have had a jolly time. Our market is at levels last seen just prior to the crisis. Dividends have also come back into fashion. Pundits are saying it's different this time (I wonder where I have heard this before) and are calling the markets higher. The potential for disturbance of this trend is unlikely to come from the weakening of the rand as our trading partners struggle with diabolical debt and the issues mentioned above. It is similarly probable that we will see rates lower for quite a while; particularly overseas as they reenergize their consumers and attempt to trade out of the mess they are in. Politics is where our risk lies and, in particular, the rather uncomfortable place the ANC finds itself in, in respect of its allies, both in Organized Labour and the ANCYL. Promises have been made to ensure votes and now it is time to deliver. This, given the precarious nature of local and international economies, is a perfect storm brewing. Last year's ridiculous wage settlements serve as a harbinger of favours being settled with scant regard to their immediate and long term impact. Particularly hard hit in this “lower for longer” environment are the less wealthy savers or pensioners, bit both by ridiculously low returns on cash and a tightening of the Fiscus in the form of direct and indirect taxes. Notably, interest returns to investors have more than halved in this cycle. Conservative pension funds are beset by this problem as well, struggling to deliver inflation beating returns net of costs. But politicians don't deserve 100% of the blame. I find the typically bipartisan arrangements within most countries' political systems, and more particularly the West, rather confounding. No matter what is being promoted or implemented, those not in power swear blindly that the policy of the day is ruinous and foolhardy. What never fails to amaze me is the blind loyalty most often showed to these clowns. The only problem is the immense
impact these political games have, and continue to have, on the public at large. Politicians are not fond of making unpopular calls. They would rather travel the road of least risk than risk defeat and an abrupt push off the gravy train. Interestingly, one country which is not much talked about, and yet has over the last twelve or so years taken the medicine, is Canada. Previously the ugly duckling of the Americas, this country cut its budgets, reduced deficits and cut head count in State and Regional Government; all in a period leading up to and in between elections. Now, during and post the economic crisis, it is reaping the rewards of these well thought through policies. Lessons might be learned by Canada's southern neighbor. Well, it is a nice thought anyhow! So, back to S.A. and our hard-hit savers and pension funds. We at NFB have, for years now, been advocates of investments with an income bias. Most of our readers would have been exposed by our advisory teams to Liberty Life's Property Fund. This large, unlisted portfolio which includes their Crown Jewels, including Sandton City, Eastgate and other mega regional centres, as well as some office and hotel assets, has for 20 plus years delivered cash and inflation thumping results, net of tax and management fees. In addition to this and other Property assets, such as listed property funds, we have used equities with higher than average dividends and Preference Share Funds to support this aim. This approach is not going to change soon. These funds and shares will, in the short term, deliver premium cash flow. When the markets finally re-rate, these investments will be rewarded as they offer similar or better capital growth, as well as superior income. It is fitting to once again remind our readers that there are many unsavoury investments out there. Much has been written about certain property funds, notably in Gauteng. We would advocate great caution when considering the reinvestment of capital from maturing investments into any but the most well known and reputable institutions. We would happily provide a second opinion if this is needed, as the risk of losing one's capital in an effort to secure a higher return, probably similar to that which you originally invested at a few years ago, is great. We wish our clients and staff all the best for 2011. May the year deliver health, happiness and good fortune to all. Mike Estment, CFP® BA CEO, NFB Financial Services Group
IN THIS ISSUE From The CEO’s Desk Retirement Annuities (RA) - The Black Sheep In Pursuit of Safety
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financial services group
RETIREMENT ANNUITIES (RA) THE BLACK SHEEP Retirement Annuities seem to have a stigma attached of being the “black sheep� of the investment product world. This stems from a history of poor explanation of the mechanics and the pricing of the investments. We will, in this article, walk through the merits of an RA and what new generation RA products offer clients. Written by Jeremy Diviani, NFB Gauteng, Private Wealth Manager
A
problem a lot of clients have with RA's is that of
investment option with open architecture so clients can chose any
underperformance. The RA can be seen as the carrier
one of the unit trust managers e.g. Investec , Coronation, Nedgroup
pigeon and does not, by itself, drive the performance,
etc. The flexibility goes so far as to include utilizing a securities
but rather it is the underlying fund selection that drives
manager (stock broker) to run their share portfolio within an RA, as
the performance of the investment. Old generation RA's offered a
long as the fund is compliant with Regulation 28 of the Pension
limited number of funds that a client could choose from and, in
Funds Act. Regulation 28 stipulates that a retirement annuity may
some instances, they were stuck with what they got. Another
not invest more than 75% in equities or 90% in equities and listed
problem may have been that investors were put into a fund that
property combined, and not more than 20% offshore. Pricing
may have been the flavour of the month and not necessarily the
mechanisms have also changed and are now more transparent,
most appropriate fund for that client's risk profile. On occasion, the
applicable and in line with the client's needs and encourages
costing mechanism used did not encourage continual advisory
continual review of the underlying funds by the advisor.
support, thereby ensuring that the underlying funds selected did not match the client's needs and risk profile. New generation retirement annuities offer clients a flexible
The big benefit of RA's is the tax benefits it offers clients in planning for their retirement. Retirement annuities are one of the few remaining tax efficiencies available. An individual is allowed to
claim a deduction for contributions to an RA on the greater of: 15%
A further benefit of an RA is that it does not carry any estate duty on
of your non-retirement funding income, R1,750 or R3,500 less your
the member's death. If your beneficiaries nominate to take a
allowable pension fund contribution.
compulsory annuity from the proceeds they will have an asset (if
If you are wondering whether you are able to obtain the tax
well managed) that can generate an income for their lives and
advantages when entering into an RA, here are a couple of basic
future generations (the income from this asset is taxable). If they
examples:
decide to take the lump sum the proceeds will be taxed according
1. If you or your company contributes to a pension or provident fund
to the relevant tax table.
and you have no other source of income then your allowable
The downside with these tax concessions is that you cannot
deduction is limited to R1,750; you can contribute a greater
access the funds before the age of 55. This can be seen as a
amount, but will not obtain the deduction on the amount in excess
positive as planning for retirement needs to become a discipline,
of R1,750 when entering into the investment.
and in today's economy/life style of instant gratification people are
2. If we continue with the example above and you earn other
reluctant to be patient and the access to retirement money can be
taxable income such as: a bonus, rental income, interest income
too attractive, if available. A lack of liquidity encourages an
then your allowable deduction is 15% of this (non-retirement
investor to put away funds on a monthly, quarterly, bi-annual or
funding) income.
annual basis and make saving for retirement a discipline and way of
3. If you are self employed or your employer does not offer a
life. The RA's contributions can also be increased, decreased,
pension or provident fund you can contribute 15% of your income to
stopped and continued at any time, allowing for some flexibility if
an RA and obtain the deduction.
you enter a tough period professionally.
Another benefit of an RA is the fact that there is no form of tax
The only caveat to this is that if you wish to emigrate you will be
on returns inside the product. This is beneficial as one of the most
allowed access to the funds on emigration (once again the funds
important elements in wealth creation is “the eighth wonder of the
will be taxed according to the relevant tax table).
world� - compound growth. The lack of taxation in an RA is (if I refer
With the cut off for RA investments being the end of February and
back to my youth) a type of gummy berry juice and enhances the
the new unit trust RA's providing a well priced, flexible investment
compounding growth rate. In our next example let's assume a client
that helps provide for your retirement while reducing your tax
has a tax rate of 40%. This client would pay 40% on any income from
liability, it is advised, if applicable, that a retirement annuity become
his investments (i.e. rental, interest income) and would pay Capital
part of your retirement plan. It also allows you, as the member,
Gains Tax of 10%. Inside the RA there is a 0% tax rate, thus
complete control and flexibility. The flexibility of fund selection
magnifying the compound growth over the investment term.
coupled with sound advice, from your NFB Wealth Manager, will
The table below depicts the tax advantages discussed above and
help drive the performance of your investment and put you in the
we can see that these enhance the return.
best possible position for a comfortable retirement. If this article has raised any queries or questions please do not hesitate to contact
Effects of Tax Advantages to RA Pre-Retirement
your NFB Wealth Manager about the benefits of a RA. Tax Table on Retirement TAXABLE INCOME FROM LUMP SUM BENEFIT
RATE OF TAX
R0 - R300,000
0%
R300,001 - R600,000
R0 plus 18% of amount over R300,000
R600,001 - R900,000
R54,000 plus 27% of amount over R600,000
R900,001 plus
R135-000 plus 36% of amount over R900,00
Key Benefits of Using a Retirement Annuity = Provides a saving vehicle that offers a tax advantage = Avoids Capital Gains Tax and Income Tax during the
investment period = Avoid Estate Duty on your savings = Earn a taxable income in your retirement years on an a
substantially enhanced capital value = Provides a retirement plan
The Subprime Crisis caused significant volatility in global markets and, although the world started
IN PURSUIT OF
to emerge from recession, 2010 unmasked the longer term issues that resulted from the crisis namely: the European debt crisis, prolonged quantitative
SAFETY
easing programs, as well as the so-called “currency wars”. Written by Nina Joannou, NFB Gauteng, Trainee Internal IFA
The Interest Rate Dilemma
expose themselves to capital volatility. This ultimately defeats the
Although South Africa has been relatively sheltered from the global
objective of being in a conservative asset class.
crisis, it has not been unaffected. South Africa has historically had high interest rates, however, interest rates have steadily declined to
So what are the alternatives?
the current prime rate of 9%, on the back of three interest rate cuts
The Sanlam Alternative Income Fund (SAIF) is primarily invested in
in 2010 (five in 2009). These cuts have been the result of a number of
cumulative redeemable unlisted preference shares with a portion in
factors, not least of which is the aim to stimulate economic growth.
money market instruments. The preference shares are guaranteed
Investors who have historically deployed their money into cash and
by top South African banks and Sanlam, minimizing credit risk. The
have received relatively high risk free returns are now faced with the
fund is not subject to current tax risks. There is 24 hour liquidity and a
reality of significantly lower interest rates. Exacerbating this problem
fixed unit price of R1, thus the capital investment will not endure the
is that tax payers with high marginal tax rates (individuals, trusts and
fluctuations similar to listed preference shares and there will be no
companies) are paying away a significant portion of this return (on
Capital Gains Tax implications upon surrender. The return on the
the interest received in excess of the tax free limits), thereby further
preference shares is a percentage of Prime which provides some
squeezing the after-tax interest income enjoyed by these investors.
protection against decreasing interest rates. SAIF also provides
In many instances, investors are earning negative real after tax
corporate investors with STC (Secondary Tax on Companies) credits.
returns after inflation is accounted for; that is to say, that after tax,
For high marginal tax payers and corporates, SAIF provides a pre-tax
the return that is being achieved is below the current rate of
yield pick-up over money market funds. In the current financial
inflation.
climate, this is a compelling “SAIF'ty” haven for surplus cash.
Dividend Income Funds (DIF's) have provided an attractive investment for high marginal tax rate payers and for companies and
Who should invest in SAIF?
trusts, due to the tax free nature of dividend income in South Africa.
= Individuals, corporates and trusts
Currently, however, many of the structures used by DIF's (in
= High marginal tax rate payers
technical terms they use the conduit principle to reduce tax in the
= Investors who have surplus cash and are looking to invest in
fund) have come under scrutiny from SARS, resulting in new Income
cash/cash proxies
Tax legislation. Due to these tax risks and lower interest rates, almost
= Investors requiring a tax efficient return in excess of the return
R5.0 billion outflow occurred in this market during 2010. Listed
generated on other cash/cash proxy investments.
BigStockPhoto.com
Preference Shares are a viable alternative, however, the investor receives a prime-linked dividend return with an equity-like volatility
The issue surrounding DIF's is a complex one, so should this appeal to
profile. Investors may be inadvertently changing the risk profile of
you, please call your financial advisor so they can discuss this with
their invested funds, meaning that in search of tax efficiency, they
you in detail.
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