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Managing one's finances is a difficult proposition though in this new column banking and personal finance issues will be addressed to help ease the process.
What is an IRA?
An Individual Retirement Account (IRA) is a personal investment account in which a person can allocate income up to a specified amount each year, invest it in stocks, bonds, mutual funds, etc and deduct the contributions from taxable income. The earnings grow tax-free with the contributions and interest being tax-deferred until retirement. In the US, the investor has choices from a wide range of banks, portfolio managers or insurance companies that can serve as trustee for his IRA account.
Even though the account is in custody, the investor has sole power of management. In the US, there are $3.475 trillion dollars managed by IRA accounts, which represent 27% of the pension plan market in the US. In Britain, as well, the pension plan patterns significantly changed when in 1990 the possibility of saving through a personal retirement account was legalized. At present, the extent of savings in personal retirement accounts totals 215 billion.
What is an Israeli IRA?
The most recent reform from the Ministry of Finance in long-term savings is the self-managed provident fund, Israel's own version of the American IRA. It is designed for one member only who is responsible for giving instructions as to investments in the account. The soon to be launched self-managing account is available, as well, to the investor who intends to manage his personal manager's insurance account.
The group proposing the personal account to the investors is obligated by the Ministry of Finance to allow them to manage it in any situation. That will enable the accounts' directors to perform interface with the various CFOs. Moreover, the accumulated reports regarding the assets in the new accounts are more complex because of the evolving composition of assets among investors.
How is a personal account managed?
In Israel, activating a personal retirement account offers an innovative model enabling the investor to take matters in his own hands, literally, as to managing his savings long-term. He has sole managing responsibility up to the smallest detail such as choosing the specific securities in his investment portfolio, without almost any restrictions or any need for authorization or external interference. However, even though the managing is the same as a standard investment account, it still is a retirement account that will be tax-exempt only if the money isn't withdrawn before reaching retirement age.
This revolution has opened a range of new investing possibilities for every citizen regardless of investment experience: buying and selling stock and securities from the stock market at will; holding any type of negotiable securities from Israel and abroad including mutual funds; dividing the management among various trust funds; or transferring it all to a portfolio director to do the job.
What are the account managing investment rules?
It is possible to purchase any negotiable asset, mutual fund or deposit in Israel or abroad. If abroad, the investor is permitted to invest only in countries with credit classifications matching Israel's or higher. One of the assets forbidden to purchase is the "structured deposit" in order to prevent the banks from attacking the new market.
In order to preserve minimal disperse, a restriction is applied, prohibiting the investor from investing more than 10% of the account's value in a single security. This restriction was intended to define the loss potential that can be caused to the investor because of a single stock investment.
The exceptional assets in this case are those whose investment extent is unlimited, such as government bonds and mutual funds.
The management fees will be collected only from the personal retirement account and not from the current deposits. Double management fee payments will remain for investment in mutual funds and for the portfolio directors payments.
What are the disadvantages of the self-management account?
This new product transfers the sole responsibility to the investor. People are likely to make mistakes and to bet hastily on their retirement savings. The existing control systems cannot prevent the investor from betting his retirement savings on risky stock and losing it all.
In other words, the more frequently an investor studies his portfolio, the more he exposes himself to unwise decisions. Statistical studies demonstrated that those who adjust their portfolios only once a year did better than those who checked their portfolios frequently.
An additional risk to consider is the rising cost of management fees. In some cases, they are bound to increase because the payment to the trustee is independent from the payment to the investment manager.
What are the advantages of the self-management account?
The personal account extends the possibilities of choice and enables exact matching between the level of risk willing to be taken and the aspired return level. The Ministry of Finance emphasizes that the use of a self-managed account will result in the following: dispersing investment decision centers among various factors; an improvement of the public's education and awareness of financial administration; and it will encourage financial groups to develop new products and services.
Moreover, the aim of the account is to enable the investor to utilize the new freedom to choose the efficient director, to choose the beneficial investment policy, to receive the best investment service from the new director including the right to change directors if one's expectations are not met. As opposed to blindly entrusting years of hard-earned retirement funds to the bank's retirement account, while receiving the yearly return report as obvious.
Finally, the activation of the personal retirement account will create competition in this field - commissions, portfolio management fees, quality of service and frequency of statements and reports - so as to please the investor.
When will the personal retirement account be valid?
Based on this month's evaluation from The Ministry of Finance, the first self-managed retirement account will be launched in the next three months. Shortly, investment groups will perceive this new field as a business opportunity and provide the required necessary services.
The writer is an adviser in the Information Risk Management Department of KPMG Somekh Chaikin. The article is published under his responsibility only.