On 9 December 2016 National Treasury issued the second draft of their retirement funds default regulations. Treasury has made numerous amendments to the first draft, which we wrote about in our article titled “Draft Default Regulations: what are we in for?”1 While many interesting issues were raised in the second draft, this article will focus on a few.
The definition of annuity strategy
The definition of ‘annuity strategy’ has been amended to an ‘opt in’ instead of an ‘opt out’ strategy.
One of the things we raised in our previous article was that Treasury always made it clear that the default regulations were not intended to force retirement fund members into default options. Members would always have the option to opt out of the default fund should the default be inappropriate for the specific needs. However, with a default conventional annuity, an annuitant would not be able to opt out as the characteristic of a conventional annuity does not allow one to transfer out. In the second draft, Treasury has amended the definition of a ‘default annuity’ so that an annuitant has the option to ‘opt in’ instead of automatically being transferred into the default, as is done for both the default investment portfolio and default preservation strategies. This change proposed by Treasury is sensible as it allows a retiring member to opt in to a default annuity strategy that may be appropriate for their needs as well as being cost-effective.
Retirement benefits counsellor
The definition of ‘retirement benefits counsellor’ has been amended to ‘retirement benefits counselling’.
This amendment puts to bed some confusion around whether every retirement fund must have a FAIS-approved individual to provide advice to every single retirement fund member. The new definition is clear in that the fund itself is able to decide how information (and not advice) is provided to its members.
Characteristics of members
The first draft requires that a default investment portfolio be appropriate for members. While this is still a requirement in the second draft, Treasury has removed the requirement that every default investment portfolio must as far as possible take account of “the likely characteristics and needs of that category of members”. The requirement that a retirement fund consider each member’s “risk and return”, “future term of membership”, “financial sophistication” and “their ability to access individual financial advice” was far too onerous and this amendment will be welcomed by retirement funds.
The active vs. passive debate
The initial draft required that retirement fund board members be able to show that “they considered the passive or enhanced passive investment of listed assets” when they design their default investment portfolio. Treasury is of the view that passive funds could be used where appropriate to lower members’ costs. Currently the majority of retirement funds have elected active investment strategies for their members, with very few considering passive investments. The second draft requires that “boards should consider both passive and active investment strategies as part of the default investment portfolio”.
The majority of retirement funds currently sit in actively managed portfolios and therefore it would be fair to say that most, if not all retirement funds in South Africa have considered active funds. Considering that such a small allocation of retirement funds currently sit in passive investments one can see why Treasury is questioning whether retirement funds have considered passive investments.
Performance fees and guarantees
Treasury has indicated in the recent past that they do not support performance fees. In the initial draft as well as with the introduction of tax-free investment products Treasury indicated that they will not allow performance fees. While performance fees are still not allowed on tax-free investment products, Treasury revised its decision to disallow performance fees in the second draft. They do indicate that they would like to see stricter compliance and monitoring of performance fees and will revisit this decision if necessary.
It seems that Treasury has done a similar U-turn on the requirement that the default investment portfolios should be purely for investment purposes only.
Currently many retirement funds offer their own default funds that are not in line with the proposed default regulations. Even though the initial draft did not specifically require it, concerns were raised regarding the potential consequences of forcing current default funds to either change their structure to meet the current proposals or transfer into new regulated default funds. Treasury has indicated in their explanatory memorandum on the draft default regulations that existing default funds will be exempt from the final default regulations. All new members going into default funds will have to be invested in the regulated default funds.
Default preservation and portability
There was some concern around the fact that the initial draft required that the “pot must follow the member”.
Treasury has now clarified that the consolidations/transfers from the default preservation fund will only be allowed if the member elects to do so. This applies to transfers to both outside retirement funds as well as the current retirement fund’s default fund. Members will always have the option to either transfer out of the default preservation fund or withdraw any allowable cash.
‘Unclaimed benefits’ is an issue that the Financial Services Board as well as other industry bodies have been trying to resolve for a while now. Treasury would like the paid-up certificates issued to members to be deposited in a centralised database. The new retirement fund that a member joins should then enquire as to whether the member has a paid-up certificate. This should assist in future with tracking members/dependants with unclaimed benefits.
In-fund vs. out-of-fund annuities
There were some concerns that the first draft only made provision for in-fund living annuities and that many of the smaller retirement funds were not in the business of providing in-fund living annuities and would therefore resort to guaranteed annuities as their defaults.
The second draft makes it clear that both in-fund and out-of-fund living annuities can be used as default annuities provided all the proposed requirements are met.
Retail funds vs. employment funds
In its explanatory memorandum, Treasury indicates that the proposed default investment portfolios will not apply to retirement annuities as it is usually a condition of these funds that a new member selects their fund choice at onboarding. Retirement annuities will also be excluded from the default preservation strategy as membership is not based on an employer-employee relationship and therefore a member is unable to resign. What is interesting though is that Treasury has indicated that the proposed default annuity strategy will apply to retirement annuities since a member is required to annuitise their benefits at retirement. It is assumed that the member will be able to opt in at any stage after they reach age 55, as a retirement annuity member is able to retire from age 55 onwards.
Treasury has specifically addressed retirement annuities in the retail space but has been silent on retail preservation funds. It would however make sense that the same concept that will apply to retirement annuities will apply to preservation funds.
While Treasury has made many amendments to their initial draft, it is encouraging to see that Treasury has, in line with its commitment to act in members’ best interests, considered the industry’s views with regard to the draft. It is also encouraging to see that Treasury is willing to introduce legislation to ensure that retirement fund members are in a much better position when they get to retirement, and are actually able to afford to retire.