Retirement reform : National Treasury’s proposals for the preservation of retirement benefits

The 2012 Member Watch Survey TM complied by Alexander Forbes Financial Services shows an average preservation rate during 2011 of 7.7%. This means that members take 92.3% of their accumulated benefits in cash when they change employment.

An individual who withdraws this much cash and continues to save at the required rate of 20% of salary until retirement will achieve a pension of only 24% of his or her pre-retirement salary at retirement. This is a mere third of the 75% that would have been accomplished with full preservation.

Preservation is critical for a comfortable retirement, which explains why it features high on the retirement reform agenda. National Treasury’s document contains five proposals to address the issue. The first two methods aim to encourage preservation whereas the last three force preservation to differing extents. We comment on each proposal in turn.

Comment: Members prefer to withdraw their accumulated benefit even when they stand to lose 10% of this amount to tax. This solution requires that an optimal tax rate is found to encourage preservation. One could argue that tax rates will have to exceed members’ marginal tax rates in order to encourage preservation. If that is not the case, an individual could see his retirement savings as a cheaper form of income than his regular income and therefore take the benefit in cash.

Comment: The benefits of members of retirement funds will automatically be preserved unless they explicitly choose to take their benefits in cash. Members will also be required to obtain financial advice before taking any portion of their benefit in cash. This strategy will require that a member receives advice and makes an informed decision. During a period of three to five years, members’ decisions will be monitored and further legislation introduced where necessary. This proposal should address financial literacy concerns… However, it is not clear whether a single financial consultation will be sufficient to empower members or whether all members have the capacity to understand the advice given. The issue of financial advisor remuneration must also be addressed.

Comment: Individuals will be able to access up to a maximum of a third of their benefits in cash, but the balance must remain invested until retirement. This method therefore makes preservation compulsory. Under this arrangement a member who contributes for 40 years at the required rate to achieve a replacement ratio of 75% at retirement will enjoy a replacement ratio of not less than 50% (all else being equal). This is more than double what current preservation behaviour results in!

Comment: Members will be required to preserve their entire benefit in full, but may make withdrawals from their savings on a monthly basis if they are unable to find employment. Such withdrawals will be limited to, for example, the lesser of R5000 or 3% of the accumulated benefit. 

This method has the advantage that it requires the preservation of benefits, but makes allowance for cash withdrawals in certain circumstances. But it is not without problems. A 3% per month withdrawal can reduce accumulated savings by 20% to 30% in a single year, which will have a detrimental impact for periods of unemployment near retirement.

Comment: Arguably the most effective method of getting members to save is to force them. Compulsory preservation will require members to preserve their benefits in full upon changing employment with no option to take a portion in cash. The major concern with this option is whether it is fair for an individual to struggle financially today in order to retire in relative comfort later.

Whatever solution Treasury adopts, financial literacy and engendering a savings culture will be very important. The lack of financial knowledge is among the main reason for the current low savings rate and therefore the ultimate issue that needs resolving. Forcing preservation could be treating the symptom (lack of savings) and not the real problem (lack of financial literacy).

One way is to offer government-funded financial wellness programmes. Another is for employers and pension providers to increase their efforts to educate and empower employees.

Members of retirement funds do not save enough for their future and drastic steps are required to address this shortfall. At the very least a comprehensive education strategy should be incorporated in Treasury’s solution to ensure that the population supports its preservation decisions and plans for their own financial future.