The costs of saving for retirement using South African financial services products remain among the most expensive in the world, reducing your ability to retire financially secure.
This shock information was disclosed by National Treasury this week as it released further details of its plans to improve the broader savings environment, which has seen South Africans withdrawing more than they have saved year-on-year since 2006.
Government has now declared war on the high cost of retirement savings, particularly in products provided by the financial services sector. And in opening the multi-front battle lines, Finance Minister Pravin Gordhan says that government is intent on a paradigm change in retirement saving. The shift has to come from:
* You, to save more;
* The financial services industry, to provide more cost-effective, transparent products; and
* Government itself, to ensure you are getting best value for money, the right incentives to save and proper protection of your savings.
Gordhan says less than 10 percent of people retire with the same income as what they earned on the last day of work. He wants to see this statistic change to 50 percent within the next 15 years.
On Monday this week he gave some indications of government’s plans to achieve this when he released the first of a series of discussion documents that should lead to fundamental changes in the broader savings industry.
He says the main beneficiary of your retirement savings must be you, not product providers or individual asset managers who are paid extraordinary sums of money.
Gordhan says one of the reasons for the low savings rate in South Africa is that, as a result of the high costs of saving, individuals are dissuaded from saving.
The lid was first lifted on the high costs of industry savings products by independent actuary Rob Rusconi in 2004. His research showed that the high costs of life assurance retirement annuities (RAs) could reduce your final retirement benefit by almost 50 percent.
He found that the most cost efficient way to save for retirement was through a large occupational retirement fund.
And now Treasury research has found that the financial services industry is still inflicting high-cost products on you – even with the new-generation RA products using linked-investment service provider (Lisp) administration platforms.
The costs are excessive measured against local occupational retirement funds as well internationally (see graph, link below).
Using a cost measurement known as reduction in yield (RiY), Treasury has found that, over 40 years, the new-generation Lisp RAs cost more than double those of a large occupational fund.
And citing other research, it has found that the costs of retirement umbrella funds, which the industry claims are a cost-effective solution, are not far behind industry RAs.
The RiYs are:
* 2.5 percent a year for new-generation RAs. (Old life assurance contractual RAs were not measured again.) This reduces your end benefit by about 40 percent over 40 years;
* About 2.1 percent a year for umbrella funds; and
* About one percent a year for large, stand-alone occupational retirement funds.
Treasury says “high cost structures erode retirement benefits, reduce savings returns and discourage participation in the voluntary system. Over the long term, high costs may threaten the (retirement) industry’s structure.”
Treasury has given the financial services sector notice that regulations might be introduced if agreement cannot be reached to improve transparency and simplify products to make the industry more competitive on costs, lowering the cost structures. Treasury and the industry are in discussion to come up with “concrete proposals”.
Currently, Treasury says, many retirement products have multiple layers of charges, including administration and investment management charges, brokerage, advice and performance fees. This makes it difficult to make comparisons across products and distribution channels.
The costs of investment management are particularly high.
And, Treasury says, the sales structures may encourage financial advisers to act in the interests of either themselves or the product provider, rather than in your best interests.
GOVERNMENT’S PLANS TO REDUCE COSTS OF SAVING
Government has a multi-pronged strategy to force down the costs of saving for retirement and encourage you to save more.
National Treasury has given a commitment that it wants to bring down the costs in co-operation with the financial services industry.
The measures include:
A change in the deduction of contributions by members of stand-alone occupational retirement funds will allow them to avoid high-cost financial sector products.
Until now you have been limited to saving 7.5 percent of your pensionable income (your basic pay excluding allowances) in an occupational fund, be it a stand-alone fund or an umbrella retirement fund.
As of next year, government proposes that you will be allowed to deduct from your taxable income:
* Below the age of 45: 22.5 percent on the higher of employment or taxable income with an annual limit of R250 000. Employer contributions are to be added to income and included in deductions.
* Age 45 and older: 27.5 percent on the higher of employment or taxable income with an annual limit of R300 000. Employer contributions are to be added to income and included in deductions.
This means that members of occupational funds will be able to ignore high-cost retirement annuities (RAs) and simply increase contributions to their occupational funds.
Treasury has a number of proposals on product structures, including:
* Standardised products, so that you are not confused by different structures but can make your choice of product on cost alone.
* Allowing exemptions from the Financial Advisory and Intermediary Services Act for “certain standardised products”. This means you won’t have to go through an adviser to buy the products, saving commission.
* Harmonising disclosure requirements across products to facilitate comparison and competition.
* Encouraging greater use of low-cost passive asset management, where your investments track market averages based on sector indices such as the FTSE/JSE All Share index.
* Limiting the inappropriate use of guaranteed and smoothed bonus funds in retirement funds.
Government is concerned about existing conflicts of interest. Its proposals include:
* Ensuring trustees, particularly of industry-provided umbrella and RA funds, are aware of their responsibilities to members. Many of these fund trustees, who are appointed by the product provider, are employees or former employees who do the bidding of the product provider.
* Preventing the cross-subsidisation of services provided to retirement funds by product providers, to ensure the information you receive is sufficient to make informed choices.
* Discouraging direct payments by product providers to advisers, especially in areas such as umbrella funds, to avoid conflicts of interest. Instead, the participating employer would pay an adviser directly. Currently, advisers are paid commissions of as much as seven percent of your contributions.
YOUR VESTED RETIREMENT FUND INTERESTS WILL BE PROTECTED
Vested interests will be protected as government makes moves to ensure that you save money for retirement, do not withdraw the money before retirement and use most of the money to buy a pension when you retire.
This assurance was given by Finance Minister Pravin Gordhan and deputy director-general of the National Treasury, Ismail Momoniat, at a media conference on government’s plans this week.
Gordhan and Momoniat emphasised that discussions are already under way with the trade unions to ensure that vested interests will be protected.
Gordhan gave notice in his Budget speech earlier this year that:
* Provident funds are scheduled for the scrap heap, by making it compulsory for the majority of retirement savings to be used to buy a pension at retirement. However, members who have an entitlement to current savings as a lump sum at retirement will not lose this entitlement, and the current exemption level of R75 000 to buy a pension with pension fund savings is likely to be increased. This will affect mainly low-income retirement fund members, who will then be able to fall back on the state old age grant.
* You will not be allowed automatically to access your retirement savings if you resign from your job and from an occupational retirement fund. Gordhan said this week that account needs to be taken of life crisis situations where members may need to access their retirement savings. The issues that are being discussed with the unions are how much money and for what reasons.
* Interest exemptions, which were left unchanged for the current tax year, will be scrapped. They are scheduled to be replaced by an income-standardised savings product from the financial services sector offering tax-free capital growth, which will be phased in and will allow you to invest R30 000 a year with a lifetime maximum of R500 000.
Momoniat says the current levels of benefits, particularly for pensioners, will be protected. If the interest exemptions are scrapped immediately and the new structure is introduced, it would take about 11 years for savers to reach the same benefit levels with the proposed savings products.
Reduction in yield (RiY): the average annual percentage amount by which costs will reduce your pension benefits.
Umbrella funds: these funds allow a number of participating employers to group together and share a retirement fund structure with the intention of reducing costs. Umbrella retirement funds come in two main guises, namely those that are structured by an industry sector body or trade union, and those provided by the financial services industry, where diverse participating employers sign up their employees for membership of a fund. The employees/members of each participating employer are ring-fenced in the umbrella fund.