Illustration: Colin Daniel

Government is to separate its drive for comprehensive social security reform from private-sector retirement reform.

This comes against a background of indications that South Africans are withdrawing more from their savings before retirement than they are actually saving for retirement. The only reason for the increase in the value of the R2-trillion savings pot is investment returns.

This situation prevails despite the fact that South Africa’s retirement system membership and contribution rates are high by international standards, with total retirement savings ranking as the largest in the world relative to gross domestic product.

The “leakage” is being exacerbated by high costs, low savings levels (the lowest in the world in 2009), consumption-driven debt and poor pension decisions in retirement.

National Treasury warns, in a discussion paper on private-sector retirement reform released this week, of a downward spiral if the situation is allowed to continue.

It warns that standards of living are under threat. The young are having to use their resources to support elderly relatives, and taxes will have to be increased to enable government to provide financial support for the poverty-stricken elderly.

Initially, former Finance Minister Trevor Manuel proposed that private-sector retirement reform should be completed by 2010, but this reform was combined with social security reform. Social security reform has become bogged down as a consequence of ideological disagreements in government.

In the discussion paper released for public comment, treasury says “social security reform is an important priority…”.

A social security reform discussion paper is scheduled for publication later this year. It will be followed by social security legislation that National Treasury says will:

* Consolidate the various social security agencies, such as the Unemployment Insurance Fund, the Workmen’s Compensation Fund and the Road Accident Fund;

* Create government’s proposed mandatory-membership National Social Security Fund, which will provide minimum retirement and assurance risk benefits to most employed individuals; and

* Encourage private retirement savings by individuals who earn more than the income ceilings set for contributions to the National Social Security Fund.

A major focus will be the private retirement fund industry, with treasury setting five priorities:

* The preservation of savings for retirement and the use of retirement savings to buy a pension for life (see “Compulsory preservation”);

* Reforming the pensions (annuity) market (see “Simpler, cheaper options for you”);

* Lowering retirement fund and pension fund costs, and making the costs more transparent and comparable. A major focus will be umbrella funds because of the accelerating closure of stand-alone occupational funds, with employers using umbrella funds provided by the financial services industry as an alternative.

* Strengthening retirement fund governance by, among other things, insisting that retirement fund trustees are properly trained.

* Uniform retirement fund taxation and regulation, which will include making state retirement funds, including the Government Employees Pension Fund, subject to the Pension Funds Act.

Simpler, cheaper pension options for you

Government is considering new pension (annuity) options to lower the cost of pensions, as well as to ensure that pensioners do not deplete their retirement savings before they die.

In a paper that expands on announcements made by Finance Minister Pravin Gordhan in his Budget speech in February, National Treasury has announced details of the options it is considering. These include:

* A simple, low-cost “default” pension product. This will enable you to buy a pension with your retirement savings without having to obtain expensive financial advice. The private sector will provide the product, but it will have to meet certain conditions in terms of design, access and costs.

* An RSA Retail Bond-based living annuity. Work is already under way on a government-sponsored living annuity where the underlying investment will be RSA Retail Bonds.

Treasury says that while the current system protects retirement fund members when they contribute to a fund, “there are surprisingly poor mechanisms for the protection of members when they retire and are even more vulnerable”.

It says most defined contribution funds and all retirement annuity funds leave members at the mercy of the retail market when they retire and have to purchase either a living annuity or a conventional annuity with two-thirds of their accumulated savings.

“Many retirees appear to make poor choices. Too few purchase conventional annuities. Most purchase (investment-linked) living annuities (illas), and must bear the risks of living too long and of poor asset returns.

“Illas require individuals to make and review complex choices, and many retirees appear to draw down their assets too quickly and invest them in funds which are too risky.”

Treasury says illas are exposing too many retired South Africans to longevity and investment risk, particularly in their late old age when they are least equipped to handle these risks. It is also concerned about illa costs, which “appear too high”.

“If members of retirement funds are to be required to annuitise their retirement assets, it is essential that the annuity (pension) market be structured in a way which encourages members to make good choices which are in their own best interests,” treasury says.

A treasury review of the annuity (pension) market found that conventional guaranteed annuities sold by life assurance companies are the only products that ensure a pension for life, but they do not appear to offer lower-income pensioners good value for money.

Drive for standardisation

National Treasury wants the financial services industry to offer standardised products that allow competition on the basis of price rather than product design.

Treasury is exploring the possibility of exempting from the Financial Advisory and Intermediary Services Act products that meet minimum criteria. These include:

* Cost structures that do not discriminate against small employers or employers with a large number of lower-paid workers, where costs are normally higher.

* Encouraging greater use of lower-cost passive investments that track indices.

* Limiting the use of guaranteed and smoothed-bonus funds in retirement funds. Government is concerned about the inappropriate use of short-term guarantees for what are long-term investments, and what appears to be the masking of investment management costs as guarantee charges.

* Limiting or entirely preventing direct payments from product providers to intermediaries, including financial advisers, especially in the group life assurance and retirement fund markets. Currently, advisers are paid up to 7.5 percent of contributions on an ongoing basis for simply signing up an employer.

* Ensuring that trustees, particularly trustees of industry-sponsored umbrella funds and retirement annuity funds, are fully aware of their responsibilities to members and do not merely do the bidding of the retirement fund administration company.

* Preventing the cross-subsidisation of different financial services, which hide higher costs within a product.

Compulsory preservation

Government is to press ahead with proposals to make it compulsory to preserve your retirement savings until you retire, but with an exemption if you fall on hard times.

The change will be phased in over a number of years to “prevent any short-term disruption to retirement savings, and to minimise the impact on current workers who may view their retirement savings as precautionary or medium-term consumption smoothing”.

In its paper on retirement saving, National Treasury says only about six percent of retirement fund members can afford to maintain their pre-retirement level of consumption after they retire. This is despite the country having high levels of retirement fund membership and high contribution rates by international standards.

Treasury wants to stop you withdrawing your retirement savings if you change jobs before retirement.

It is proposing to make it easier for you, if you change jobs, to leave your accumulated savings in the retirement fund provided by your former employer, to transfer your savings to the fund offered by your new employer, or to transfer your savings to a financial services industry preservation fund.

However, treasury is recommending that if you leave your job for whatever reason and are unable to find new employment, you be allowed to withdraw a maximum of one-third of your accumulated savings after you have exhausted your benefits from the Unemployment Insurance Fund.

Treasury has also proposed that you be allowed to make limited withdrawals “in the case of demonstrated medical need”.

Strict rules for pension funds

Government is considering making it compulsory for all retirement funds to be managed in accordance with guidelines set by the Financial Services Board (FSB).

The guidelines, entitled “Pension Fund Circular 130: Good Governance of Retirement Funds” (PF 130), were published in June 2007.

In line with this approach, National Treasury is also considering imposing stricter conditions for people becoming retirement fund trustees, with, for example, a statutory requirement that trustees be “fit and proper” and have no criminal record.

The FSB could declare trustees “prohibited persons” if they are found to have been involved in transgressing the requirements for good pension fund governance.

Other measures proposed to improve the governance and management of retirement funds include professionalising the role of principal officers and strengthening the enforcement of current laws.

Treasury says an essential element of any retirement system is good governance and trust.

“Members make contributions to their pension funds that they may use only when they are retired in many years’ time. They have a right to expect that their funds will be managed prudently and in their best interests, in line with current law.”

But, treasury says, “there have recently been some lamentable high-profile lapses in governance that, if unchecked, threaten the trust that is the basis of any financial system”.

PF 130 is currently only a guidance note for fund trustees, suggesting they put in place a code of conduct, an investment statement and a communication strategy to members, and have a performance appraisal system for trustees.

Government is considering making it compulsory for trustees to have relevant qualifications and expertise in the management of pension funds.

PF 130 also places an obligation on new board members to receive comprehensive training and for all board members to undergo training on an ongoing basis.

To assist in the training and development of fund trustees, the FSB has launched a voluntary online education programme, the Trustee Toolkit.

Treasury says it is receiving active support from both industry and trade union leaders to improve fund governance.

It says the industry “recognises that practices like surplus-stripping and bulking by a few administrators undermine the entire industry”.