Government’s reforms are changing the retirement-planning landscape, whether you are saving for retirement or about to retire, John Anderson, Alexander Forbes’s managing director of research and product development, says. This is the first article in a series of reports on the Personal Finance/Alexander Forbes Ready Set Retire conferences that were held around South Africa this month.
Government’s reforms of the retirement-funding industry are extensive. The aim is to ensure that you save adequately for retirement and that your savings are properly protected, John Anderson says.
The reforms have been driven by a number of factors, including:
* The huge switch from defined benefit (DB) funds to defined contribution (DC) funds;
* The fact that most people, on changing jobs, do not preserve their retirement savings; and
* The need for retirement-savings products to provide consumers with value for money.
Anderson says that planning for retirement has been made considerably more difficult by the swing away from DB funds, where you were assured of a predetermined pension, to DC funds, where you bear the risks that you will save enough money by the time you retire and, once you retire, manage your savings in such a way that they will provide a sustainable income for the rest of your life.
Almost 80 percent of private sector retirement funds are now DC funds, he says.
It is impossible to calculate once-off how much you should save for retirement and how much money you will have at retirement, Anderson says. Numerous variables affect both calculations, including investment returns, the rate at which your salary will increase, how much you contribute to your retirement savings, for how long you contribute and how many years you are likely to live in retirement.
“There are many complex decisions you have to make, and the onus is on you to make the correct decisions. The only way to do this is to empower yourself by learning about the retirement environment,” Anderson says.
And he warns that one big mistake may have a severe impact on your income in retirement.
You need to review your retirement plans regularly to take account of changes in your financial situation and changes in legislation.
Government, with its reform programme, is increasingly intervening to help you make the correct decisions and ensure that you are offered cost-effective products.
Anderson says the reforms are changing the retirement-planning landscape. The main changes are:
Preservation
Anderson says the average member of an occupational retirement fund retires with a pension that is equivalent to less than 30 percent of his or her final pay cheque. To put it another way, for every R100 that members earned before retirement, they receive only R30 as a pension. One of the main reasons for this shortfall is that employees do not preserve their retirement savings when they change jobs.
The average employee works for seven different employers over his or her working life. On changing jobs, nine out of 10 fund members cash in their retirement savings and spend them, Anderson says.
Starting to save late in life and withdrawing your savings before you retire are certain to result in a financially insecure retirement.
National Treasury wants to make it harder for you to withdraw cash lump sums from occupational retirement funds before retirement.
However, it is proposed that you will be allowed to withdraw a limited amount each year, although these withdrawals will affect the amount you can withdraw at retirement and the tax you will pay.
Any new restrictions on pre-retirement withdrawals are likely to apply only to contributions made after the measures have been introduced; your existing right to make pre-retirement withdrawals will apply to amounts saved before the measures are introduced.
Taxation of contributions
Contributions to the various types of retirement funds are taxed in different ways, Anderson says.
One of government’s reforms is a single rate at which all contributions can be claimed as a tax deduction, irrespective of the type of fund. This change is due to take effect on March 1 next year.
The change will enable most members of retirement funds to claim more of their contributions as a tax deduction. However, the tax-free contribution will be capped at a rand amount each year.
Type of pension
Even if you save enough money to buy a sustainable pension, Anderson says that you face financial challenges at retirement, of which the main one relates to longevity.
If you retire at age 60, you can, on average, expect to live for 22 years if you are a man, or 27 years if you are a woman, he says.
If you want to retire after working for 35 years, you will probably have to save an amount that is equal to about 20 percent of your income, Anderson says. The average contribution to a retirement fund is 13.5 percent of pensionable income.
The reality is that you may have to work longer than you thought you would and save for longer.
The DC environment places the onus on you to choose the right pension product. The issue is more complex than many people think it is, and often an incorrect decision cannot be undone, Anderson says.
National Treasury is concerned that most retirees prefer to buy investment-linked living annuities, where you decide on the underlying investments and choose a drawdown rate of between 2.5 percent and 17.5 percent of the annual capital value.
Anderson says that, although a living annuity can be an appropriate choice, problems occur when pensioners do not understand the risks associated with these pro-ducts. Pensioners can outlive their savings, particularly if their drawdown rate is too high.
However, he also pointed out that, no matter what pension product you choose, it cannot compensate for not having sufficient savings.
Annuitisation
National Treasury would like you to use all of your retirement savings to buy a pension (this is known as annuitisation), Anderson says.
Pension funds and retirement annuity funds limit the amount that you can take in cash at retirement to one-third of your benefit. You must use the remaining two-thirds of the benefit to buy an annuity. However, if your benefit is R75 000 or less, you can take the full amount as a cash lump sum.
Members of provident funds can take the entire benefit as a cash lump sum. This will change next year, when provident fund members will also have to annuitise part of their benefit, although members will not forfeit any existing rights to take the entire benefit as cash.
Fund governance
Government is giving attention to how retirement funds are governed, Anderson says.
The new regulatory regime for the entire financial services sector, Treating Customers Fairly, has “huge implications” for the retirement industry, he says.
“The process is only starting now, but it is also aimed at ensuring you get a better pension.”
Government is also trying to persuade employers to play a bigger role in helping their employees to make appropriate decisions at every stage of their retirement planning, including when they retire.
Costs
For many South Africans in formal employment, retirement fund benefits are their only long-term savings, Anderson says.
In the absence of a comprehensive social security system, he says that government relies on the financial services industry to provide products that will help you to save for retirement. Therefore, government, which provides tax incentives for you to save for retirement, wants the industry to be competitive and to offer cost-effective products.
National Treasury believes the cost of saving in a retirement fund must be reduced so you receive a higher pension. It proposes stricter control over product costs and better disclosure of costs. Treasury also wants to reduce the number of funds, particularly small funds.
A LIFE-LONG PROCESS
Retirement planning is from cradle to grave and is a four-stage process, John Anderson says. The four stages are:
1. Value creation, which is when you are growing up and being educated. This stage will, to a large extent, determine your earnings potential and your financial status in retirement. This is the stage when you build up your human capital.
2. Accumulation, which is when you convert your human capital into an income and use some of that income to save for retirement – something that you should do from the day you receive your first payslip.
3. Intermediate stage, which is when you reach retirement age but do not retire. Instead, you start a second career or a business, either because you want to or because you have not saved enough to retire.
Anderson says it is becoming increasingly important that people postpone retirement, particularly if they have not saved enough.
“Depending on how much you have saved, retiring at age 67, instead of 65, can add 15 to 30 percent to your pension.”
4. Decumulation, which is when you retire and use the assets you have accumulated to support yourself and possibly a partner.