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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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