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The no-go zones of tax-free savings accounts

Products with performance fees excluded.

JOHANNESBURG – Products that charge performance fees will not qualify for inclusion in tax-free savings accounts, National Treasury says.

This proposal was revealed in a draft notice and regulations it issued on Friday. It seems that these types of products do not adhere to the principles of simplicity, transparency and suitability treasury has set as benchmarks for inclusion.

Cecil Morden, chief director for economic tax analysis at National Treasury, says the concern is that the nature of the fees investors will have to pay is uncertain.

Performance fees can also fluctuate quite a lot and can become rather costly, especially for an uninformed investor, he says.

Tax-free savings accounts are due to be introduced on March 1 next year, but are still a work in progress and consultation is ongoing. Following its introduction investors would be allowed to contribute R30 000 a year to a tax-free savings account. A lifetime capital contribution limit of R500 000 will apply. All proceeds on amounts invested in these accounts will be tax-free.

The introduction of tax-free savings accounts is an effort to encourage South Africans to save and to lessen their financial vulnerability and dependence on credit. Government also hopes to grow the general savings levels in the country with the incentive.

In a statement issued alongside the draft notice and regulations for these accounts, treasury indicated that licenced banks, long-term insurance companies, managers of registered unit trusts, authorised users, platforms (linked investment service providers) and government would be allowed to offer these accounts.

“However those products may not have restrictions on when those returns are paid or on the level of returns paid to the individual,” it said.

Pieter Koekemoer, head of personal investments at Coronation Fund Managers, says the disallowance of products that charge performance fees is an unfortunate outcome. National Treasury is effective prejudging the issue.

Koekemoer explains that the industry has agreed to develop a best practice guide on performance fees in collaboration with the Association for Savings and Investment SA (Asisa). The idea was that the document would provide a basis for further consultation with Treasury and the Financial Services Board. This followed criticism against performance fees in Treasury’s discussion paper on charges in the retirement industry.

Koekemoer says the best practice guide was completed in the last few weeks. He says it is therefore premature to issue specific rules in the tax-free savings accounts environment and believes the issue should rather be considered in the broader unit trust setting.

In the interim, every asset manager that charges performance fees will have to decide how to handle the issue.

Koekemoer says in their case over 60% of unit trust assets are invested in funds that do not charge performance fees and they do have a core range of suitable funds to offer in the initial period.

Since they believe there is an outstanding consultation process that has to be completed in order to understand the long-term position they won’t rush to change any fee structures, he says.

Shalin Bhagwan, portfolio manager at Ashburton Investments, says the standard in the unit trust industry is not to charge performance fees.

“So you could probably find that most unit trusts will be eligible,” he says.

Performance fees are more prevalent in esoteric type products like hedge funds, he says.

Bhagwan says a blanket exclusion of any product with a performance fee is probably not appropriate, but one should also consider that these products are targeted at middle income savers and that it is an effort to get some basic savings going.

Treasury also proposed that products that “expose an investor to an excessive level of market risk” should be excluded.

Morden says they tried to keep the products that would qualify for inclusion simple. The man in the street might have difficulty to fully comprehend the nature of a structured product (for example where a product guarantees a return and any returns in excess of that is payable to the service provider).

In terms of the current proposal investors must also be allowed to access their money within seven business days after they requested it.

Bhagwan says that while it is admirable that treasury is trying to protect middle income earners from excessive levels of risk and from investing money in illiquid instruments, the unfortunate outcome could be that managers who choose to participate in this space launch very conservative products that don’t deliver the type of investment returns needed to beat inflation in the long run.

This could mean that long-term investors in these accounts could be very disappointed if they find out that the real value of their money has gone down after five or ten years and that they did not manage to beat inflation.

Bhagwan says it would be helpful for treasury to provide clearer guidance on what they consider to be excessive levels of market risk and to consider setting up model portfolios that they would consider acceptable.

This could be done in much the same way as Regulation 28 for pension funds provide guidance on the maximum exposure to certain asset classes.

As far as fixed deposits or policies with a guaranteed return are concerned, Treasury has indicated that early withdrawal penalties will be allowed, but these have to remain within certain specified limits.

The draft regulations also address the composition of investments and the withdrawal fees allowed.

Morden says the proposals try to ensure a level of diversification – that investors don’t put all their money into one basket and then run the risk of losing it if they chase high returns over the short-term.

He says they struggled to come up with a withdrawal fee structure that could be uniformly applied across various products.

“We do understand that there is a role for exit charges for various reasons but it should be reasonable.”

Written comments on the draft notice and regulations for tax-free savings accounts should be submitted to Treasury by December 3.

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