Five reasons why you cannot depend on your employer’s pension fund for your retirement
South Africa has a tax-incentivised private pension and provident industry which also provides life insurance, death benefits and disability insurance to retirement fund members. Do you have access to these retirement benefits? If you do, will your fund provide for your needs?
Reason One: Not all employees have the option of contributing to a retirement fund
To state the obvious; you may have to provide for your own retirement simply because your employer does not even have a retirement fund. Less than half of working South Africans contribute to a retirement fund. The latest Labour Force Survey released by Statistics SA reports that there are approximately 10 million South Africans with formal sector jobs, while National Treasury estimates that only 6 million South Africans contribute to an employer pension fund.
Four million South Africans working in the formal sector either elect not to join an employer managed retirement fund, or work for a small or medium sized company that pays staff on a ‘cost to company’ basis, leaving staff to make provision for retirement, medical cover and disability. You might be one of these four million workers who are obliged to make your own plans for retirement.
The problem of small companies not playing a role in collecting retirement savings is a problem in other countries too. The United Kingdom has recently introduced an automatic enrolment programme which requires all companies that employ more than one person to enrol by 2018. (this para could be left out)
A further 28% of working South Africans make up the ‘informal’ sector, (those who are self employed), agricultural workers and those who work in domestic households. While it is possible that individual employers may make investments on behalf of their household staff, it is the exception rather than the norm.
Fig 1: Less than half (approximately 6 million people) of 14 million employed South Africans contribute to a retirement fund.
Reason Two: The costs of managing a retirement fund can be high
Maybe you are one of the lucky ones and your employer deducts money from your salary every month for your retirement and other benefits. But this is no reason for complacency.
All retirement funds perform a variety of functions on behalf of their members. Such tasks include collecting money from contributors, paying money out to retirees, providing financial advice to members, following up beneficiaries and managing and administering investments. Recent research on the cost of retirement funds published by National Treasury has found that costs depend on the size of the pension fund, the degree of preservation, whether or not contributions are compulsory or not, how the assets are invested, the nature of the tasks performed by the pension fund and the quality of services.
The draft findings of research released by National Treasury in July 2013 showed that South African retirement costs and fees were relatively high and that hidden charges were a problem, particularly for low-income earners.
The treasury also found that fees were not sufficiently disclosed, and there was a tendency to shift from upfront charges to recurring charges. The most expensive retirement products in South Africa were found to be the ‘old generation’ Retirement Annuities with an annual cost of about 3%, (calculated over 40 years) while the most cost effective were industry funds with relatively few participating employers, and a likely degree of employer subsidy. The annual cost of such funds was in the region of 0.5%.
Figure 2: Effect of recurring charges on retirement fund accumulations after 40 years
Source: Charges in South African retirement funds, published by National Treasury, July 2013 Pg 9
It is clear that the higher the level of fees and charges, the lower the return of the remaining assets that are invested. Figure 2, above, shows the impact of fees and charges in retirement funds over a 40 year period, assuming that the contribution rate remains constant. The table shows that annual recurring charges of 2% of assets under management can reduce a member’s retirement benefit by some 40% over 40 years of employment.
Reason Three: The level and cost of risk benefits such as life insurance and disability cover, can be high, depending on the profile of your retirement fund
Most South African pension funds allocate a portion of the income they receive to death benefits and disability benefits in the event that some workers die before retirement age. Employees are not permitted to ‘opt out’ of this benefit. Although longevity is increasing due to the rollout of antiretroviral medication, the HIV /AIDS epidemic is still expected to extract an awful cost on the economy and the lives of workers. Mortality projections indicate that the number of working age deaths is expected to exceed numbers of new retirements in the next few years.
The six million workers who have access to employer funded retirement benefits (see above) have access to a lump sum death benefit of 2 – 3 times annual salary at an average cost of approximately 2% of salary cialis discount paris. Disability benefits consist either of a similar lump sum, or more expensive income benefits of 75% of salary, which on average cost about 1.5% of salary.
It follows that the more workers claim death benefits, the less money remains for retirement benefits. The level and cost of risk benefits such as life insurance and disability allowances detract from the ultimate performance of assets that remain in the retirement fund.
Reason Four: Investment choices of the trustees of the retirement fund
Investment choices made by the trustees of retirement funds have a significant impact on the ultimate value of assets in a retirement fund. If the assets are managed with a low risk, low equity mandate, the fund may not experience the same rate of growth that a less conservatively managed fund might experience. Many members of occupational retirement funds have no say in how their retirement assets are managed, while in other funds where members do have a choice, research shows that investors who make their own investment choices invest too conservatively, thus limiting the growth of investment returns.
The choice of investment vehicles selected by trustees also has a cost implication. Passive investments such as index funds and exchange traded funds are usually cheaper than actively managed investment. Investments in alternative asset classes such as property, private equity and hedge funds are sometimes more expensive, and yet carry no investment guarantees.
Reason Five: Low preservation rates and a system that allows for ‘leakage’
One of the main reasons that your employer’s retirement fund might not be enough for your retirement actually has nothing to do with the cost of the fund or the choice of investments; it has more to do with choices that you make when changing jobs.
South African law allows employees leaving pension or provident funds on job changes to access their entire retirement balances in cash, although tax is payable on the withdrawal of a lump sum benefit pre-retirement. Divorced? Your husband or wife may be granted lump sum cash payments in terms of a divorce order.
This problem of ‘leakage’ is a weakness in our current retirement system and also has major negative implications for South Africa’s long-term savings. Household saving has been in negative territory since 1998. Unfortunately most employees seem to choose to take their retirement benefits in cash. According to the 2011 Sanlam Benchmark Survey, 107 members out of 152 (70 per cent) who left retirement funds through resignation or retrenchment withdrew from retirement funds, 9 per cent preserved part of the benefit while taking the rest in cash, and only 2 per cent moved the benefit to the prospective employer’s fund. Leakage is particularly difficult to address given the South African economy’s structural problems; if you are retrenched or unemployed many people have no choice other than to draw on a pension fund.
References
Charges in South African retirement funds, published by National and published in July 2013
Preservation, portability and governance for retirement funds, published by National Treasury, September 2012.
Risk benefit provision through provident and pension funds, Research undertaken for South African National Treasury by Genesis Analytics (Pty) Ltd.
Quarterly Labour Survey, published by Statistics SA, September 2013.