How not to be worse off when you retire
Retirement funds estimate that less than 30 percent of their members will be able to maintain their standard of living when they retire, the latest Benchmark retirement fund survey by Sanlam Employee Benefits shows.
The principal officers of standalone occupational funds – or funds sponsored by an employer – estimate that only 29 percent of their members will be able to maintain their standard of living when they retire, while umbrella funds – those that cater for different employers who do not have their own retirement funds – estimate that only 26 percent of their members will maintain their standard of living.
In union-sponsored funds, the trustees estimate that only 17 percent of members will maintain their standard of living in retirement.
There are a number of reasons retirees are likely to find their retirement income insufficient, but one of the biggest problems is that members do not preserve their savings when they change jobs.
A number of findings in the survey reveal the extent of the problem:
* 24 percent of active members of stand-alone funds interviewed had withdrawn their savings on resignation or retrenchment;
* 20.8 percent of pensioners interviewed said they had, at some stage, withdrawn their savings on resignation or retrenchment;
* Employers participating in umbrella funds reported that 90 percent of their members withdraw their savings when their employment ends;
* Occupational fund principal officers and trustees say more than 70 percent of their funds’ members withdraw their savings when their employment ends; and
* Union-sponsored funds say 85 percent of members who leave an employer withdraw their savings.
Among the 24 percent of active members who withdrew their retirement savings at some stage in their careers, 54 percent took the entire benefit in cash, 59 percent used the cash to settle debt, while 40 percent used the money for living expenses.
The pensioners stated that their main reasons for taking the cash were to settle debt (60 percent) and for living expenses (52 percent).
National Treasury has plans to introduce legislation that will compel members of retirement funds to save their benefits when they leave an employer.
Treasury has suggested that, once this legislation has been passed, you should be allowed one withdrawal each year, up to 10 percent of the value of the fund from which you withdraw.
In a discussion document released earlier this year, Treasury also proposed that retirement funds, by default, preserve your savings in the fund if you leave your employer before retirement, rather than the current default which is to pay you your savings in cash. This means that when you leave your job and your fund, your savings will be preserved, unless you specifically request the fund to pay you out.
Treasury has also proposed that funds choose a default annuity (pension) for retirees, and that funds that offer investment choice adopt a default investment option.
The task of choosing an annuity to provide an income in your retirement is a daunting one for anyone. The Sanlam survey found that most trustees welcomed Treasury’s proposal that funds provide a default annuity. Eight out of 100 stand-alone occupational funds already have a default annuity in place.
At least 40 percent of trustees report that their funds expect to have a default annuity in place within the next 12 to 24 months.
Living annuities allow you to make your own investment choices and potentially leave a legacy to your children, but they come with the very high risk of you outliving your savings or withdrawing so much that you are forced to reduce your income once your withdrawals reach the maximum allowed limit.
Guaranteed annuities, on the other hand, give you an income for life, but if you outlive a “guaranteed period”, typically 10 years, your heirs won’t benefit when you die.
The survey shows that most members (62 percent) want their employers to provide them with a pension, even if they do not know what form the pension will take or what increases they can expect from it.
Two other reasons members of retirement funds are forced to lower their living standards in retirement are that they retire too young or retire with dependants, or both.
According to the survey of fund members, the average retirement age remained constant from last year’s survey: 62 years.
The survey of pensioners in 2013 revealed that 63.1 percent of them retired before the age of 65.
Kobus Hanekom, the head of strategy, governance and compliance at Simeka Consultants and Actuaries, says “they may not realise the very big price they had to pay” for opting for an earlier retirement.
He says the survey indicates that, on average, members and their employers are contributing 12.5 percent of income to their retirement funds after the deduction of costs and premiums for life and disability cover (see graph, link at the bottom of the article).
At this contribution rate and an average investment return of the inflation rate plus 5.5 percentage points, retirement funds estimate that you should, after 35 to 40 years of saving, without withdrawing any of your savings, achieve a pension equal to 75 percent of your income.
(Last week, Personal Finance published the latest Alexander Forbes Index, which showed that members who were on track to retire with 75 percent of their pensionable income may not reach this target as a result of increasing costs of buying a pension at retirement and expected lower returns.)
The pension target changes, however, if you do not continue working to the age of 65 but decide instead to retire at 60. In this case, your total contribution (member and employer’s contribution) needs to be 17.5 percent of your income throughout your working life, Hanekom says.
Compound interest on your savings in the last few years of your working life is significant, Hanekom says. From age 60 to 65, your expected pension, expressed as a percentage of your income, can increase from 55 percent to 79 percent.
If you postpone your retirement by two years beyond age 65, you can increase your pension to 91 percent of your working income. If you postpone retirement by another three years, to age 70, you will increase your pension to 114 percent of your income.
Another finding of the survey is that most present-day pensioners started to work at the age of 22 but started saving, on average, only at the age of 26. The four-year hiatus, with compounding over an entire working career, even at low salary levels experienced in the early years of your working life, can result in a significant difference.
Dawie de Villiers, the chief executive officer of Sanlam Employee Benefits, says the survey of members and pensioners shows that South Africans are not ready to retire at the age of 65, “and the problem is exacerbated year on year”.
One in five of the 250 pensioners interviewed for the Benchmark survey indicated that they supplement their retirement income with part-time work and, in most cases, it is out of pure necessity.
De Villiers says the traditional family structure and capital requirements at retirement no longer hold true, and the issues require fresh insight.
Most of the pensioners surveyed indicated that they have an adult or children who are financially dependent on them.
“In essence, people have less money to live on at retirement, but are living longer and have significantly greater financial burdens,” De Villiers says.
Principal officers and trustees of 100 occupational funds, 100 representatives of employers participating in umbrella funds were interviewed. It also incorporated 512 interviews with fund members and 250 interviews with retirees.
CONTRIBUTIONS NOT BASED ON ENTIRE INCOME
Beware of pension projections that are based on income that is less than your total pay package. Many retirement fund members’ contributions are based on income that makes up only 80 percent of their pay package, the Sanlam Benchmark survey shows.
Retirement fund contributions are often based on what is known as pensionable earnings, or retirement-funding income, which typically excludes bonuses, allowances for travel or cellphones, as well as overtime payments.
Kobus Hanekom, from Simeka Consultants and Actuaries, says many funds allow their members to adjust their pensionable income relative to their non-pensionable income in order to increase their take-home pay.
Most funds state that they aim to provide a pension that replaces 75 percent of your income. The pension target is expressed as a “projected pension ratio” or as a “net replacement ratio”, but the ratios are typically calculated on your pensionable earnings.
So the 75-percent target is therefore often only targeting three-quarters of 80 percent of your total pay, which can result in a big drop in income at retirement.
The targeted pension is expected to be enough for you if you have paid off your home loan and your children have left home.
But many pensioners are not in this position. The survey found that 40 percent of retirees still have debt in the form of a mortgage bond, credit card debt, personal loan or even vehicle finance when they retire.
Hanekom says death and disability benefits are also typically based on your pensionable income, and members or their families are often disappointed to find that the benefits are much less than expected.
He recommends that funds use next year’s change in the limit on tax-deductible contributions to a retirement fund to change their contribution formulae and encourage you, as a member, to contribute to the fund in line with your needs.
He says the most compelling way to do this is to make pensionable income equal to your total pay package, or, if your income fluctuates, to base it on an average remuneration and then to adjust the amount contributed.
EMPLOYERS CONTRIBUTE LESS
The average amount that employers contribute to retirement funds has decreased from 9.91 percent of pensionable income over the past five years to 9.66 percent in 2014, the Sanlam Benchmark survey shows.
The average contribution by members has increased from a five-year average of 6.05 percent to 6.44 percent, bringing the total amount members are saving into retirement funds marginally higher at 12.5 percent of their pensionable income, from 12 percent last year.
Danie van Zyl, the head of guaranteed investments at Sanlam, says these changes may have been made in readiness for changes to the tax-deductibility of retirement fund contributions next year.
As of March next year, employer contributions to your retirement fund will be a taxable fringe benefit, but the tax deduction for both employee and employer contributions will increase to 27.5 percent of your taxable income.
The survey notes that 39 percent of funds allow members to choose their own contribution levels. Van Zyl says most members choose the lowest contribution level and not the level they need to save enough for retirement.