Get ready! Retirement reform is on the horizon

Government has plans to implement a National Social Security Fund (NSSF) within the next five years. The experts say this implementation could take considerably longer as government diverts resources to job creation and the National Health System (NHI).

Do not be fooled, however, into thinking that retirement reform is forgotten. Further steps towards reform were announced when Finance Minister Pravin Gordhan delivered his 2012 National Budget speech in February this year. He announced changes to the treatment of retirement annuity tax deductions and a new form of savings vehicle, among other proposals.

Retirement reform presents numerous South Africa-specific challenges. Top of the list is the unfortunate reality that a large portion of the lower income market will not reach normal retirement age.

Low life expectancy necessitates a focus on medium-term savings and life and disability benefits over longer-term retirement provisioning. In this regard provident funds offer a vital medium-term safety net for many workers. On the other hand, higher paid workers have different needs.

The current retirement system, which allows members to cash out their accumulated retirement benefits when changing jobs, has led to gross under-provision in this segment of the market. How will government address these problems?

A first step is to do away with provident funds in their current form. Retirement reform will introduce compulsory annuitisation, which means provident fund members will no longer be able to withdraw their entire savings upon retirement. Instead, they will be subject to a maximum one-third withdrawal upon retirement, in line with the current pension funds regime.

Government is likely to change the rules for compulsory annuities too, in a move to promote post-retirement flexibility. This is exactly what happened in the UK, where retirees can defer taking benefits from their fund indefinitely, or draw down an unlimited income upon proof that they have a lifetime pension income of at least £20,000 a year.In a bid to promote greater competition in the retirement savings space Gordhan also proposed Retirement Income Drawdown Annuities (RIDDAS) be offered by more providers, including Collective Investment fund managers. Previously, only compulsory annuities were allowed – and only through companies with a life license.

Government could also promote annuitisation through a smaller tax-free portion on the lump sum and greater tax relief on monthly annuities. And if provident funds are not scrapped, government could apply new rules to minimise lump sum withdrawals from these vehicles. Such limits are already imposed in the rules of many provident funds. The good news is that if South Africans are forced to annuitise they will make better provisions for retirement.

Equally important to annuitisation, is the preservation of funds. South Africa is one of a few countries in the world where preservation is not mandatory and billions of rand leak out of the retirement savings environment as a result.

The evidence suggests that if government plugs this hole in the run up to the NSSF it could make a considerable positive impact on the country’s retirement savings provisions. Australia introduced tighter limits in 1999 and the sector had grown fivefold to about $8-trillion by June 2010.

Under the current rules retirement savings can voluntarily transfer their accumulated retirement capital to preservation funds. These funds – which financial advisers can assist in choosing – offer a seamless transition for members of provident and pension funds that are retrenched or change employment.

The country’s large life insurers and pension fund administrators typically offer in-house preservation funds that allow their clients to switch to preservation vehicles cost effectively and efficiently. In this way your savings remain at the same firm without the need for a separate preservation fund comprising different investment vehicles and cost structures. Existing risk benefits can be maintained too.

Momentum Employee Benefits believes that such solutions, coupled with appropriate financial advice, will encourage individuals to resist withdrawing their savings before retirement age.