Default regulations to the Pension Funds Act which became effective September 1 2017, with all funds having to be compliant by March 1 2019, require defined contribution retirement funds to offer members a pension at retirement. This means that, if you are a member of a pension or provident fund through your employer, you can choose to either buy a pension on the retail market in the form of a life or living annuity or retain your capital in the fund which, in turn, pays a pension income in the form of a living annuity.
It is essential to understand the key differences of in-fund and out-of-fund annuities, with the first being that an out-of-fund living annuity is acquired from a service provider in your name, whereas with an in-fund living annuity, your retirement money stays invested in the portfolios offered by your fund. As such, you remain a member of the fund and the trustees retain protection and oversight responsibilities in terms of the Pension Funds Act and the fund’s rules.
These regulations were borne out of a desire to ensure that retirees are adequately supported and informed when having to make critical decisions at the point of retirement, bearing in mind that retirement counsellors provided by an employer group are not permitted to give advice, but instead serve to inform retirees of their in-fund options. Whereas previously retirees had to invest in an annuity through the retail market, these regulations ensure that employers put mechanisms in place that provide employees with an in-fund annuity option.
Purchasing the most appropriate annuity for your circumstances is a critical decision because it can fundamentally impact the quality of your retirement years. The retail annuity market comes with a huge array of products and annuity structures and, to a certain extent, the provision of an in-fund annuity option takes the complexities out of the decision-making process. The fact that in-fund annuities generally offer lower investment fees because the economies of scale in the retirement fund makes them attractive to retirees. Having said that, an investment should not be selected on the basis of fees alone and there are many other factors to consider before opting for the in-fund option.
Other than costs, some key differences between in-fund and out-of-fund annuity options include the following:
If you elect to keep your retirement capital in an in-fund annuity, bear in mind that your money effectively remains in your employer’s pension and/or provident fund and will be regulated by the Pension Funds Act. This has a number of implications which are worth noting. Importantly, this means that Section 37C of the Pension Funds Act applies in the event of your death. As such, while you may nominate beneficiaries to your annuity, it remains the duty of the fund trustees to allocate and pay the death benefits in a manner that they deem fair and equitable in the event of your passing. While they may use your beneficiary nomination as a guide, they are under no obligation to honour your wishes. Instead, they have a duty to conduct an investigation to establish your financial dependants, and then to make a distribution according to their findings.
On the other hand, should you purchase an out-of-fund annuity, your investment will be regulated by the Long Term Insurance Act and is governed as an individual insurance contract in your name. As it does not fall within the auspices of the Pension Funds Act, you are free to nominate beneficiaries to your policy and, in the event of your death, the capital remaining in your annuity will be paid directly to your nominated heirs. If leaving a financial legacy to a particular beneficiary or set of beneficiaries is important to you, then it is important to take cognisance of this distinction.
As retirement capital housed in an in-fund annuity is regulated by the Pension Funds Act, it is also important to note that the funds are subject to Regulation 28. In terms of these regulations, retirement funds are limited to certain asset classes including equities, property and foreign assets, and further limit the percentage of funds that can be allocated to each asset. In terms of Regulation 28, a fund’s underlying portfolio is limited to a 75% exposure to equities, 25% in local or international property, a maximum limit of 30% offshore assets, and 10% in hedge funds. On the other hand, investors in out-of-fund annuities, are not governed by Regulation 28 and thus have complete control of their portfolio construction depending on their investment horizon and the returns they need, giving them the option to invest 100% of their funds offshore if so desired.
In terms of Regulation 39, the trustees of the fund have an oversight responsibility to monitor the fund and to ensure it remains sustainable. As such, they are required to review the fund on an annual basis to ensure that it remains compliant with legislation and appropriate to the needs of its members. It also states that a maximum of four underlying funds may be made available for member choice and that these must remain Regulation 28 compliant. They also have a responsibility to report regularly to the members regarding the fund composition, fund performance and any changes in fund choice.
On the other hand, no such oversight happens in an out-of-fund annuity as it is essentially a contract between the investor and the service provider. The service provider has a responsibility to invest the funds according to the mandate of the investor and to report regularly on the fund performance, but it remains the investor’s responsibility to adjust their drawdown levels as they see fit and to adjust their investment strategy in accordance with their needs.
From an administrative perspective, implementing an in-fund annuity is less burdensome although retirees are required to expressly opt to retain their capital in the in-fund annuity. The Fica requirements are fewer as the retiree is already a member of the fund, whereas if setting up an out-of-fund annuity the retiree will have to comply with all Fica legislation. While the transfer to an in-house annuity is seamless because the capital effectively remains in the fund, setting up an out-of-fund annuity involves some administrative effort and paperwork.
If you choose to retain your retirement capital in an in-fund annuity, you have the option at a later stage to convert it to an out-of-fund annuity. However, once your capital is invested in an out-of-fund annuity, you cannot convert it back into an in-fund annuity.
Protection from creditors
In terms of Sections 37A and 37B of the Pension Funds Act, the funds held in an in-fund annuity are protected in the event that a member becomes insolvent. This means that any lump sums or pension benefit payable as an annuity do not form part of the member’s insolvent estate and, as such, cannot be attached by creditors. On the other hand, while the capital held in an out-of-fund living annuity may not be attached by creditors in the event of insolvency, any income withdrawn by the annuitant does not enjoy the same protection and can be attached by creditors.