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BusinessDay www.businessday.co.za Thursday 10 February 2022
INSIGHTS
RETIREMENT FUND INVESTMENTS
Balanced portfolio the best defence The last few weeks of January, yet again, were a reminder to investors of just how quickly things can and do change in financial markets, and why a balanced portfolio of assets remains the best defence for long-term investors. “Towards the end of 2021, we were very bullish about South African equities and worried about global equities, given high valuations and elevated levels of exuberance,” says Pieter Koekemoer, head of
Personal Investments at Coronation Fund Managers. “Today, we maintain our view that the local equity market offers meaningful upside to fair value, despite the strong recovery since the onset of the pandemic.” Following the recent selloff in global markets, Koekemoer says Coronation is now also optimistic about the opportunities being presented to stock pickers, given the dramatic declines that have
taken place in some parts of the market. “The correction in global markets is a positive,” he says, adding that long-term investors could do well by ensuring they have healthy levels of exposure to all asset classes, especially the domestic asset classes and global equities. “The exception is global bonds, where we expect returns to be anaemic over the next decade,” he warns. While investors might be
tempted to head for safety in this market environment, now is not the time to be sitting in cash, he says. “We believe that investing in a balanced, well-diversified portfolio of assets remains the most appropriate choice for most long-term investors, allowing skilled professionals to take advantage of these opportunities as and when they are present and rebalance exposure to the different asset classes on behalf of investors.”
How much money is enough to retire? One of the most common questions posed to financial planners is how much money is required for retirement. Travis McClure, a private wealth manager at NFB Private Wealth Management, says his standard answer to this is “as much as possible”. “A simple calculation for how much money you need once you are retired would be 20 times your annual salary or required annual income. So, assuming you need R30,000 per month as your retirement income, you would need 20 x R360,000 which is R7.2m.” This amount would allow the retiree to withdraw an annual income of 5% per
annum off the capital and any excess growth above that would go back into the capital to ensure some growth in income and capital against inflation. What income percentage or withdrawal rate is the right number? “It all depends on your budget,” says McClure. “The ideal number should be between 3%-6% per annum.” This allows for some capital growth over and above the income percentage, he explains. “Most pension or cautious to moderate portfolios target inflation plus 3% to 4%. With average inflation running at about 5% to 6% per annum, this means that should the portfolio return 9% and you draw 4%
there is 5% in capital growth on your pension.” With that, he adds, comes an increase in income each year as the capital grows. However, drawing too high an income can put the capital at risk. “If one starts to draw into capital you can get into a dangerous spiral as the withdrawal rate just increases as the capital depletes. This makes it harder for the capital to recover and you run the risk of running out of capital in your lifetime,” he cautions. Inflation, warns McClure, is a retiree’s biggest risk. “Retirees need to ensure the purchasing power of their money keeps pace with inflation.”
Other risks include market risk, economic risks, health risks and a withdrawal rate risk. How much risk should retirees be prepared to take? “When someone retires, they move from a capital growth phase to an income phase,” explains McClure. “Although the retirement portfolio should become more income based — with a focus on assets that provide more of an income yield and have less volatility like cash, bonds and property — one cannot ignore the need for growth assets.” For retirement capital to keep pace with inflation one should have a portion invested in growth assets, he advises.
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Values shift: staying in touch is critical
Be aware of all •options to protect your financial security, writes Lynette Dicey
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inancial security in retirement matters more than ever and it’s important to be clear on when guaranteed income makes more sense than living annuities. According to the Living Annuities Survey compiled by the Association for Savings and Investment South Africa (Asisa), living annuity policyholders managed to keep the average drawdown rate practically unchanged at about 6.6% pre-pandemic. However, the steep rise in the cost of living in SA could have a big impact on this with many people already drawing the maximum allowed percentage of 17.5%, says Stephan le Roux, a registered financial planning coach at Old Mutual Wealth.
WHAT’S THE DIFFERENCE BETWEEN A 35-YEAR-OLD AND A 65-YEAR-OLD?
Stephan le Roux … volatility. “It’s also important to be aware of the dangers of personal preconceptions of what is required for retirement. Values shift over time and it’s critical to stay in touch not only with the world as it was, but also the world as it is and could be,” he adds. In 2019, research and consulting organisation LIMRA did a study called The Value of Guarantees to establish investors’ views and perceptions around taking the lump sum or the guaranteed income at retirement. This study revealed that 47% would like to convert a portion of their assets into an income. However, as they approach retirement this figure drops to 30%. The study found that more than one-third of pre-retiree and retiree investors want to use a guaranteed income to cover their basic living expenses and nonguaranteed sources to cover the rest. Added to this, context and framing are critical in assessing how many people would like a guaranteed income: a hypothetical choice between a guaranteed income and a lump sum (as opposed to parting with own assets to generate an income) led to 52% of pre-retirees and retirees choosing the guarantee. “The preference for a guaranteed income is driven by an expectation of living longer and a desire for peace of mind,” explains Le Roux, adding that
those who choose the lump sum do so mainly because they want control of their money. The study revealed that the core emotional value of guaranteed income is “peace of mind”. Other factors are protection during cognitive decline, ability to take more risks with other lump sums and improved retirement lifestyles. It also found – perhaps not surprisingly – that those with a preference for guarantees tend to have less wealth and financial sophistication. Generation X and Millennials, in particular, prefer guaranteed incomes. Flexible income is one of the main reasons why living annuities are so popular. “Investors want to feel in control of their annual drawdown percentages,” he says. “Another consideration is flexible investment options, particularly if bequests need to be made. In this case there is a bigger responsibility to manage behaviour and expectations.” What about the risks? “Sequence-of-return risk becomes a danger when withdrawals are made from a fund’s underlying investments,” says Le Roux, explaining that the order or the sequence of annual investment returns is a primary concern for retirees living off the capital of their investments. “Negative returns in the early years of a living annuity investment will have a drastic effect on capital. This may result in the capital being depleted a lot sooner than if those negative returns arose later on, leaving no capital to draw from.” Research shows that portfolio volatility, often treated as substantially less important than investment returns, matters a lot for living annuity investors. “In fact, higher portfolio volatility in an incomeproducing portfolio acts as a drain on portfolio performance. Conversely, lower volatility seems to ‘create’ additional returns for an incomeproducing portfolio because it helps the portfolio manage
sequence-of-return risk more effectively,” explains Le Roux. When choosing a living annuity, he advises, select a portfolio that targets real growth with low volatility to ensure you are optimally positioned for success despite what might happen in the markets. For drawdowns exceeding 4% per annum, a living annuity investment strategy should aim for at least 60% exposure to equities, he says. “Returns have an impact: for every 1% additional real return, about 0.9% per annum of additional sustainable income is generated. About 0.1% of sustainable income seems to get lost through time value of money and the fact that incomes are reviewed only once a year,” says Le Roux. Volatility also has an impact. “For every 1% reduction in the level of volatility, an additional 0.3% per annum of income could be taken,” he says, revealing that volatility can be managed through active asset allocation, manager selection and smoothing portfolio returns. The six steps which provide peace of mind in retirement, says Le Roux, are to make use of guaranteed annuities for haveto-haves; use living annuities for nice-to-haves and long-term emergencies; use discretionary investments for short-term expenses and emergencies; ensure enough growth; minimise volatility; and use dynamic withdrawal strategies. “When it comes to retirement the basic guidelines are not to increase withdrawals and to defer ad-hoc expenses after a negative year and only give a 10% real ‘raise’ if capital reaches 150% of the initial investment. Understanding and distinguishing between needs and goals is key to a successful outcome in retirement. Ultimately, it’s important to understand all your retirement options before committing to a solution so you are optimally positioned despite what might happen in the markets.”
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BusinessDay www.businessday.co.za Thursday 10 February 2022
INSIGHTS: RETIREMENT FUND INVESTMENTS
Funds: ‘consider increasing allocation in unlisted space’ Regulation 28 of the Pension Funds Act aims to protect retirement funds by limiting the extent to which they may invest in a particular asset or asset class. Proposed amendments to Regulation 28 are intended to encourage more investment in infrastructure and provide pension fund trustees with the ability to explore opportunities in the unlisted space. In SA, retirement funds have traditionally not utilised the unlisted space, including investments in the infrastructure space, as much as they could have, says Natalie Phillips, deputy MD at Ninety One. However, this trends looks to be changing. She explains that the investment environment has changed significantly in recent years with a far smaller opportunity set on the JSE, which is currently dominated by rand hedges. “In 2012 the JSE all share had 162 constituents. A decade later this has reduced to 143 constituents with 70% of the top 40 on the JSE made of JSE hedges. This means that along with a shrinking domestic universe, funds are essentially doubling up on their offshore exposures, which is why we think that pension funds should consider making a bigger allocation to the unlisted space.” In the retirement fund space, the smaller opportunity set on the JSE is starting to lead to a growing appetite for infrastructure and impact credit, says Phillips, adding that Ninety One anticipates growth in this asset class in the next five years. Both the high yield credit and infrastructure spaces provide
Reap the benefits of retirement annuities
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I Natalie Phillips.
Simon Howie.
Nkhumeleni Thavhiwa.
diversified exposure that is not correlated to the listed market, while the lock-in period of seven to eight years – or longer – is ideally suited to retirement funds, points out Phillips. “Retirement funds benefit from a much smoother return profile. Since 2008 these investments have delivered an annualised return of about 12% to 13% per annum,” she says. Investment specialist at Ninety One, Nkhumeleni Thavhiwa, says that in recent years there has been a clear shift across emerging markets towards providing debt in noncyclical businesses such as infrastructure and other real assets. “Despite SA having lagged in recent years, steps by government and industry bodies are laying the platform to correct this imbalance,” he says. For SA to fulfil its potential, sustainable and inclusive economic growth is critical. This requires reliable infrastructure. However, lack of investment in critical infrastructure such as energy, rail, roads and ports has been one of the contributing factors to poor economic growth in SA, says Thavhiwa.
“Government appears to have the political will to address SA’s infrastructure deficit with the establishment of the Investment and Infrastructure Office, led by Kgosientso Ramokgopa, and which is located in the Presidency, a positive indicator of the importance placed on infrastructure investment.” The near-term opportunities, he adds, are in renewable energy, including selfgeneration and the small-scale embedded generation sector. Other opportunities include telecommunications, transport and logistics and housing. Simon Howie, co-head of SA & SA Fixed Income at Ninety One, says that, as a credit investor, Ninety One believes it has a key role to play in ensuring funding is available for viable projects. “Infrastructure investment presents an opportunity to support the country’s economic growth while at the same time providing good long-term returns for retirement funds.” He says the investment opportunity is in both equity and credit. “For retirement funds, equity offers the potential for long-term investments
underpinned by real assets, with the potential for upside. However, the bulk of the opportunity will be in credit not only because the debt component is far larger in most projects, but also because many projects will be owned by government, state-owned entities or corporates. An important consideration is the nature of the credit investment, says Howie. “Rated and listed debt will be necessary to truly unlock the full depth of capital markets. This is an important role for funds that can invest in private debt.” Ninety One has been investing in infrastructure through the Emerging Africa Infrastructure Fund, a debt fund that focuses on sustainable infrastructure across the continent. The fund has more than 42 investments and more than $1bn in committed capital. “The infrastructure opportunity is compelling and already forms a cornerstone of our debt portfolio,” says Howie. “Debt provides an opportunity to sensibly deploy into physical assets at scale while meaningfully contributing towards SA’s future growth.”
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nvesting for retirement through a retirement annuity (RA) is an effective and rewarding way to save for retirement because of the unique benefits offered. The most significant benefit, says Natalie Kiewitt, executive of Operations at PPS Investments, is the fact that it provides unparalleled tax savings, which can be used to boost retirement savings. “With an RA, you can contribute monthly or as a lump sum before the end of each tax year up to the limits set by Sars,” she explains. “The current tax year ends on February 28 2022, and you can contribute up to 27.5% of your annual taxable income, subject to a maximum tax deduction limit of R350,000 per annum.” The tax deduction limit applies to the cumulative annual retirement contributions, regardless of whether they have been directed to RA, a pension or a provident fund. Encouragingly, Sars does not penalise individuals for contributions that exceed the allowable limits. “In fact,” says Kiewitt, “the tax benefit can be carried forward to reduce tax liability in future tax years if you exceed the 27.5% maximum contribution limit. Ultimately, the more you top up your RA contribution for the tax year, the higher the tax benefit.” In addition to the taxdeductible premiums, RAs are exempt from tax on dividends and interest, and no capital gains tax is payable on growth earned
in the investment. The tax benefits extend to retirement. Upon retirement, the investor can make a withdrawal of up to one-third of the investment as a lump sum. The first R500,000 is tax free. “Any lump sum withdrawal exceeding the R500,000 taxfree portion will be taxed according to the retirement tax tables,” says Kiewitt. “If you have more than one RA or retirement savings vehicles, the withdrawal limit applies to your total retirement savings amount.” An RA offers tax benefits and is designed to provide a structured approach to saving towards retirement over time, along with features to help safeguard retirement savings. One of the features of an RA is that your retirement savings are protected from creditors. “This means if you are declared insolvent, creditors are not allowed to access your retirement funding. An RA benefit is also not subject to estate duty, which means it can be used to support surviving dependents,” says Kiewitt.
The biggest advantage of topping up an RA is that it boosts retirement savings over the long term, allowing the power of compound interest to take full effect over time. “You can further boost your retirement savings by reinvesting the tax rebate received from Sars when you include your RA contributions in your tax return,” she says. “The graph below shows the impact of topping up. In this example, an investor earns an annual salary of R500,000 and contributes 7.5% of her taxable income into her retirement annuity. She earns an annual bonus of R100,000. In one scenario, she does not top up her RA and, in the other, she uses 30% of her bonus for the RA top-up. The result is that after 15 years, her retirement savings grew by 80% more when compared to the scenario where she did not top up.” Deciding not to top up your retirement annuity in favour of having more disposable income can be tempting but in the long run the benefits of topping up
Source: PPS Investments. For illustrative purposes only. Performance is not guaranteed. Growth at CPI+4%.
your retirement annuity far outweigh the decision not to, she insists. Once you have taken advantage of all the tax benefits available through retirement annuity contributions, Kiewitt suggests considering a tax-free investment that can help you reap even more tax benefits and bolster retirement savings. “Offering an investment option with zero tax on investment income or growth and no dividend withholding tax you can invest up to R36,000 per tax year until you reach the lifetime limit of R500,000.” While a tax-free investment is not designed to be a sole source of retirement savings, it presents an opportunity to boost the investor’s nest egg with a lump sum. The tax-free investment is not subject to Regulation 28 (part of the Pension Funds Act) which limits the percentage allocated across assets or asset classes offering more freedom around choosing investment options. Kiewitt cautions, however, it’s important to note that if you exceed the annual or lifetime limit there are significant tax penalties that could erode the value of your investment. “As we approach the end of the tax year, you have a few weeks left to take advantage of the tax benefits available through your RA and tax-free investment account. Essentially, you can pay less tax while boosting your retirement nest egg or simply investing tax free towards your goals.”