NFB FINANCIAL UPDATE Volume61 Mar2012
FROM THE CEO’s DESK
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alamity having been avoided in Europe for the time being, and considering the way forward, I thought it appropriate to consider how opportunity is found where investors' biases overshadow logic. We at NFB continue to scour the markets for anomalies, and whether you are Warren Buffett with a proven record of buying value and holding, or a Momentum manager who tracks shorter term trends and runs with them, quite happy to buy and sell in weeks or months, you will agree that finding anomalies where for some reason or the other, the security, be it a share, bond or market index, is miss-priced on the cheap side, represents a great investment opportunity. There are caveats to this statement, i.e. "cheap" is always to be seen as a potential opportunity, in the case of the baby being let out with the bathwater, but certainly not in the case of a share where “cheap” is just a point on the way to de-listing or insolvency! Many examples of “cheap” have been seen over the last few years and an example of these that still exists today, involves, amongst others, quite a few South African banks and large corporates who borrow both domestically and abroad. Examples are the major five banks, a few of the largest assurers and corporates such as Anglos and SAB Miller to name a few. Due to the stress in capital markets abroad, the borrowers have had to pay up for the capital they need for projects or to strengthen their Balance Sheets, in the case of banks and other financial institutions. Add to the search for capital the relative obscurity of the S.A. institutional borrowers names and track record, and you end up with the likes of Investec, Standard Bank, Old Mutual, Anglos et al, borrowing at very attractive premiums to what is reasonable. So, what this means is that we are investigating these opportunities for potential foreign investment. We do this in two ways. The first is as a total return option where the investor doesn't need income or is simply comfortable to just accept the return. The second, whilst being a little more complicated, is where the bond, issued by the borrowers listed above, provides us with a coupon. This coupon is an interest payment paid twice annually (or sometimes more frequently) and this is deployed into a more
aggressive growth oriented portfolio, selected and managed by NFB's stock broking partners in London. A further option is the creation of what we call a tranche. This would involve us using one of these bonds to provide a guaranteed outcome, on top of which we purchase positive participation in a very liquid global index, such as the S&P 500, the Dow or similar. This approach leads one to a guaranteed outcome, five odd years down the track, and obviates the current low or no return environment being experienced by investors in Bank Deposits. Changing focus back to local for the conclusion of this editorial, I thought it appropriate to take a look at NFB's in-house Fund of Funds and recently-introduced Model Portfolios, and how they are stacking up. The danger of comparisons, especially in the investment arena, is that they are done over short term periods where the advertiser has done well. I, therefore, am much more interested in the medium to long term, where performance and risk mitigation play out and influence long term results. In the case of both our Cautious and Balanced Funds, I am delighted to report sustained superior returns and, very importantly, whilst taking less risk than our peers. We will shortly have a five year track record for these funds. This, in an industry where reporting is critical, represents the true coming of age of the NFB funds. We will be taking on the giants of the industry and look forward, through the development of our own in-house solutions, together with a close and intimate understanding of client needs and portfolio makeup, to delivering market leading results for many years to come. This industry is all about scale. This term means "How much money do you have?". I would like to thank the advisors and our clients who have supported these solutions, as together we have built up very large assets and accordingly have allowed our asset management team the ability to wage an ongoing sortie to reduce excessive fees, which simply means better medium and long term returns to the Model Portfolios and, in turn, us as investors. Mike Estment, BA CFP® CEO, NFB Financial Services Group
IN THIS ISSUE From the CEO’s desk Undressed, a retirement annuity proves attractive Life cover premium patterns
financial services group
Undressed, a retirement annuity proves attractive The naked retirement annuity - evolving from an ugly duckling to a sophisticated swan. By Philip Bartlett, NFB East London, Private Wealth Manager
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t is often that I witness the gun shy response to the words “retirement annuity”. The pain of a product sold for profit by a commission hungry salesperson, subject to terms and escalation with few, if any, asset class options, and the tale of woe handed down from father to child, only to be blindly upheld as the “trick” to miss. One would have to concede the point that an industry previously measured by unregulated sales has probably been responsible for an entire generation of investors being conditioned to run for the hills when hearing the words “retirement annuity”. However, it is not the structure of the product that gave birth to the cynicism, but rather the contractual terms, escalating premiums, penalties, limited fund choice, and failure on part of the advisor to marry the client's investment objective with an appropriate solution. In the “good old days”, the product providers paid their sellers an upfront commission based on the term of the investment - the longer the term the bigger the commission. The longer the term, the more likely a default on contributions became. A default would result in breach of contract, and lo and behold, a breach would give rise to a penalty. Importantly, these costs are attributed to the contract one entered into with the product provider and are not born out of any complexities associated with the retirement annuity structure.
The truth of the matter is that investment planning involves a strategy required to accommodate the journey of the investor's life. The need for flexibility must be considered and catered for. What with the continued evolution of financial products, and prices, it would be naive to take and hold a position from any one point in time to retirement. Remove the contractual terms and the naked retirement annuity evolves from ugly duckling to sophisticated swan, challenging the greatest cynic to review his stance and offering significant advantages when it comes to tax and estate planning. What isn't to like about an investment that is = Protected from creditors, = Allows for tax deductible contributions up to 15% of non pensionable income, = Gives you the flexibility of making single and/or regular investments, and allows one to stop, start, or vary your contributions at any time without penalty, = Allows for tax free growth on all capital within the structure – that means no CGT, no dividends tax, and no income tax. In today's fiscal context, the latter is very significant, = On the death of the investor, lump sums received by beneficiaries are exempt from estate duty,
= Beneficiaries can also take advantage of tax free
amounts in the event that contributions had previously been disallowed (this will become clear by way of later example). OK, so where's the catch? = Well you can't retire from the investment until the
minimum age of 55 years = And you are limited to withdrawing 1/3 of the capital,
which is subject to specific tax tables (as per below), and utilising the remaining 2/3 for income by way of compulsory or living annuity. Retirement Benefit Taxable Portion Taxable income Rate of Tax R0 - R315,000 0% of taxable income R315, 001 - R630,000 18% R630, 001 - R945,000 R56, 700 plus 27% over R630,000 R945, 001 and above R141, 750 plus 36% over R945, 000 Is the restriction on liquidity a real show stopper? The underlying question must be: why would you want to access all the funds? What are you going to do with this money? Retirement is about the generation of income off a growing capital base, right? Why then would you withdraw all your capital, erode it by paying tax, and then invest it in a fully taxable investment in a bid to effect growth and generate income, pay CGT, dividends tax and income tax, die and then pay estate duty and executors fees!! It seems self defeating. Although dictated by legislation, the restriction to liquidity actually prescribes the path you ought to follow anyway, which is to preserve the tax free status of your capital by transferring to a living annuity, prevent the eroding effects of CGT and dividends tax, limit income tax and avoid paying estate duty where legitimately possible. So restricted or not, one ought not to withdraw the capital anyway. Further, the myth that retirement annuities can only invest in old school, non-transparent portfolios can also be put to bed. It is now possible to have your retirement annuity invested entirely into a managed share portfolio, and actively participate in the management thereof. Besides actual bricks and mortar and other private interests, there are very few investment assets that can't be accessed through a retirement annuity.
Retirement Annuities as an Effective Estate Planning Tool There are many administratively onerous and complex strategies offered to counter the eroding effects of estate duty, be it an inter vivos trust, the use of a usufruct, donations or a Section 4q – spouse nomination. A retirement annuity offers a very simple and very effective tool in this regard. The full value is paid out on death and is free of any estate duty. Add the benefit of disallowed tax deductible contributions being paid out free of tax to the beneficiary, and one can literally calculate the savings. By way of example: Mr A has a vast estate and wishes to reduce his estate duty liability. He donates R3 million to a retirement annuity,
R450 000 is deductable (assumed) and the balance is not allowed as a tax deduction. He dies two years later, with a retirement annuity value of R3 600 000. The estate implications for his contribution are as follows: = The full amount plus untaxed growth will pay out directly to his beneficiaries, assumed value of R3 600 000; = There is no Estate Duty of 20%; = There are no Executor's fees of up to 4%; = Net saving of up to R864 000 for the estate; = The tax-free portion of the payout to the beneficiaries is R315 000 plus any disallowed tax-deductible contribution. The tax-free portion is therefore R315 000 + (R3 000 000 R450 000) = R2 865 000; = The taxable portion of R735 000 will be taxed in accordance to the tax tables above = R179 550; = The amount realised by beneficiaries would therefore be R2 865 000 + (R735 000-R179 550)= R3 420 450 Had Mr A not contributed to the retirement annuity, the following would be realised by his beneficiaries: = The growth from R3 000 000 to R3 600 000 would be taxed. Let's assume a conservative 20% over the 2 years = R120 000; = Less Estate Duty at 20% = R696 000; = Less Executors Fee at 4% = R144 000; = The amount realised by beneficiaries would therefore be R2 640 000 In this example, the beneficiaries, through the use of the retirement annuity come out R780 450 better off.
Retirement Annuities as Effective Investment Planning Vehicles for Business Owners Most small business owners earn non-retirement funding income i.e. they are not salaried and paying into a pension or provident fund. Hence, 15% of their gross earnings is allowed as a tax-deduction if contributed to a retirement annuity. A business owner who generated an annual income of R1 000 000 could contribute a tax-free annual amount of R150 000 into a portfolio that will grow tax free. There is indeed a tax at withdrawal, but at a reduced rate when compared to the normal income tax tables. If the investor's tax-deductible contributions amounted to a value of R2 835 000 at retirement, he could withdraw the R945 000 and pay only 15% tax (see above tax tables) on the income, as opposed to up to 40% paid by the upper income bracket. That being said, he could avoid paying tax entirely by transferring the full amount to a living annuity. Apart from the huge tax savings available, the funds are also protected against insolvency, allowing the business owner further security. Taking the above into consideration, it can't be denied that the retirement annuity structure offers an investor a very effective vehicle to avoid the depletion of retirement capital by way of taxes and estate duty. The compounded savings is indeed significant, if you take the time to do the numbers. The bad reputation may well have been warranted against the dressed up retirement annuity tarts of the past, but in its naked form, the modern retirement annuity proves to be quite a catch!
Life Cover premium patterns By Laurie Wiid, NFB Gauteng, Director
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hen purchasing Life insurance, it's important to establish the reason why you require Life insurance. Generally, Life insurance is a grudge purchase, but most certainly has its merits. Essentially life cover is put in place to ensure that your dependents will be able to maintain their standard of living should you pass away. The lump sum paid on your death to your beneficiaries is used as a capital injection that you have otherwise not accumulated through investment. Other purposes for life cover are as follows:
= Settling of debt = Liquidity for estate duty purposes (Estate duty, income tax and capital gains tax) = Provision for your dependents = Business assurance needs
Whilst there are many factors that influence your life cover premium, it is also important to understand the different premium options available to you. The premium pattern you choose has a significant effect on the costing structure of your policy. Depending on your age, affordability at outset and the purpose of the risk policy, you can structure a premium pattern to suit your needs. Although benefits offered by different life companies may differ slightly, it is essential to look at the premium and benefit patterns when comparing life quotations up against one another. We will discuss the three main premium patterns below.
inception of the policy, but as the life assured gets older the premium increases at an age factor on an annual basis. Age rated premiums are generally selected for business assurance purposes and for those that require cheaper premiums at outset with an ability to afford more expensive premiums in the future.
Compulsory Premium Pattern This type of premium pattern has a compulsory premium increase of 5%, 10% or 15% on an annual basis. The higher you select your compulsory premium increase, the cheaper the premiums will be at inception of the policy. In conclusion, to weigh up the cost of one premium pattern relative to another, you have to cost the policy over the period for which you are likely to need it. Although level premium patterns are more expensive initially, they become more cost effective over the longer term. A 5% compulsory premium pattern can be even more cost effective over the short term, and an Age Rated premium pattern even more so. Although these two premium patterns do become more expensive over the long term, it is important to understand the purpose and related premium pattern for which the life cover was intended. This can provide guidance in choosing the right premium pattern for you and your business needs. As your personal or business circumstances change, so too will the need for cover, and, as such, it is important to have your life cover policy reviewed every 2 – 3 years.
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Level Premium Pattern Level premium patterns are more expensive at inception of the policy, but because premiums do not increase as you get older, the level premium pattern will be cheaper later on in life. If you select not to have an annual benefit increase, the premiums will stay constant. If, however, you wish to have your benefits increase annually, the premiums will increase in a smooth fashion.
Age Rated Premium Pattern An age rated premium pattern is cheaper at
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