Pension-providing products face a major overhaul that could see your retirement fund playing a bigger role in your choice of pension at retirement and new limitations on investment-linked living annuities (illas), as well as the reform of life assurance guaranteed pensions.
In the discussion paper entitled “Enabling a better income in retirement”, National Treasury spells out various options to reform the pension market in an attempt to ensure you receive a better pension and one that will last for the rest of your life after you retire.
These include requiring pensioners to use a pre-determined minimum of their tax-incentivised retirement savings to buy a life assurance-guaranteed annuity that will pay you a pension until you die. Only after you have purchased this guaranteed annuity will you be permitted to invest in an illa, where the risk that you will receive a sustainable pension for life lies with you.
Other significant options being proposed by Treasury are:
* A requirement that pension funds provide a default pension option to all fund members at retirement, providing members with a low-cost, low-risk pension into which they could move seamlessly and without financial advice. The pension could be provided by the financial services industry or by the fund itself.
* Fundamental reform of illas to ensure a sustainable pension is provided for life. This includes further restrictions on the amounts you can draw down from illas (the current range is 2.5 to 17.5 percent of retirement savings). Treasury is proposing that age-related drawdown maximums are introduced, more conservative prudential investment restrictions apply to the retirement capital providing the pension, and simplified investment structures to reduce risk and the amount of financial advice required.
* The introduction of a simplified, lower-cost, lower-risk, new range of investment-linked living annuity-type pensions called retirement income trusts (Rits) that will eventually replace illas (see “New pension structures”, below).
* Introducing commission/ advice fee restrictions to limit products, such as illas, being aggressively sold because of the potential for intermediaries to earn more from illas than from traditional guaranteed pensions.
* The introduction of minimum standards for traditional guaranteed pensions, including:
- Capital preservation on death, such as the continued payment of the pension to heirs for the first five years of the pension contract if the pensioner dies within the period;
- Minimum annual pension increases, for example three percent a year or half the inflation rate; and
- Mandatory pensions for spouses after the death of the pensioner, set at two-thirds of the benefit level enjoyed by the pensioner.
* Encouraging large life assurance companies to take more factors into account when assessing how much they will pay you as a pension. For example, Treasury suggests factors such as your health and your lifestyle could be taken into account rather than simply your age and gender. People at higher risk of dying young would then receive better pensions than the healthy. This will mean that wealthy people who can afford healthy lifestyles and medical care will pay more for the same pension than low-income earners, who typically have shorter lifespans.
* Limiting life assurance companies to selling guaranteed pensions and excluding them from selling illas.
New annuity structures
National Treasury is proposing two new pension-providing products, namely variable annuities and retirement income trusts.
1. Variable annuities
Variable annuities take existing with-profit annuities a stage further. With-profit annuities guarantee your starting pension and your pension increases – dependent on the returns on the underlying investments – which are added to the guarantee.
However, the future of these products is in doubt, because, internationally, life assurance companies are expected to have more onerous cash reserve requirements imposed on them, and South Africa is likely to follow suit.
Variable annuities share the risk between the life assurer and the pensioner, which means pensions would increase in favourable investment markets, but could go down in unfavourable markets; or could be adjusted up or down if the pension group as a whole died earlier or lived longer than expected.
The initial pension would be based on the capital amount, how long you are expected to live and the expected investment returns to be earned on assets.
2. Retirement income trusts
Retirement income trusts (Rits), which may be modelled on the legal structure of collective investment schemes to give the same levels of transparency and protection enjoyed by collective investments, will:
* Have age-dependent pension drawdown limits, which will include all recurring charges;
* Not provide any investment choice, but you will be allowed to split your retirement savings between Rits offering different investment strategies;
* Pay death benefits to your nominated beneficiary that equal the value of the residual savings at death;
* Be subject to prudential asset limits similar to, but possibly more conservative than, the current prudential regulations that apply to the build-up of retirement savings;
* Strictly limit commissions payable to intermediaries, with these advice fees or consulting fees being paid by the product provider and not retirement funds; and
* Permit members to transfer to other Rits or to guaranteed life annuities free of charge, with strict limits on the commission that can be paid on transferred monies.