This regular column is intended to address any financial problems that Money readers may encounter.

Which will give me a better pension: retirement annuities or unit trusts? - IV

Some argue in favour of retirement annuities (RAs) because of their apparent tax benefits. But Foord's testing of these perceived benefits has concluded differently.

In principle, investors in an RA obtain a tax benefit on a small amount. This amount should grow considerably, and the resulting annuity (conceivably, a greater amount) will be subject to income tax. By contrast, while no tax deduction is offered on a discretionary investment into unit trusts, the later drawdowns are subject principally to the more benign capital gains tax.

We have considered the effects of estate duty (from which RAs are exempt), variations in the taxable yield on unit trusts (on which an investor would be taxed while accumulating savings, and on which no tax is payable in an RA fund), differing pre-retirement income scenarios, measures taken by the revenue authorities to reduce fiscal drag, and a variety of accumulation and drawdown periods.

The analysis shows that the discretionary unit trust investment, devoid of any upfront and seemingly attractive tax benefits, trumps the retirement annuities over time.

We argue that disciplined investors are better off investing their retirement savings directly into discretionary unit trusts than in RAs.

The proposed revisions to Regulation 28 of the Pension Funds Act make our argument compelling.

Draft changes to the act, which governs how the underlying assets of a retirement fund may be invested, are likely to make RAs less beneficial.

The purport of Regulation 28 is to provide prudential guidelines for the investment of the assets of a retirement fund; the rationale is that without such regulations, investment managers, or investors themselves, may invest the assets inappropriately or injudiciously.

The pretext of the proposed amendments is to update definitions and to take account of modern developments in the financial markets.

However, they have also imposed some additional restrictions, not the least of which pertains to an RA investor having to ensure his or her individual compliance with Regulation 28's investment spreading requirements.

These restrictions may ultimately render the RA a fundamentally less desirable product, as RA clients who sought the apparent benefit of the tax deduction but the freedom to invest in pure equity or pure offshore exposures will no longer be afforded that discretion.

The investment restrictions of Regulation 28 have resulted in an astute investment manager being able to implement something short of a best investment view.

This necessarily lowers the potential for returns (and, indeed, reduces the scope for the necessary and appropriate management of the risk of loss).

In Foord's case, for example, the Balanced Fund complies with the requirements of Regulation 28 (and so it may be selected for inclusion in an RA portfolio), but the unrestricted Flexible Fund of Funds represents the very best investment view that the house has to offer.

Possibly, perversely in the minds of some observers, an unrestricted mandate allows the investment manager to diversify the portfolio far more thoroughly than under a restricted mandate, since there are no "default" allocations - every investment decision is made on its merits and in comparison to other opportunities.