Changing times require rethink for retirement funds

It all sounds so simple - spend 40 years saving, then retire and spend the rest of your life enjoying the fruits of your labour. However, for most members of retirement funds the reality is very different indeed.

Economic and lifestyle changes, particularly over the last few years, means that in many ways, traditional assumptions used in the design of retirement fund benefits no longer apply.

For example, whereas in the past many people followed a “one company for life” policy, these days members who continue to work until retirement age will have changed jobs four to seven times as their career develops, often belonging to a number of funds during their working lifetime.

The number of opportunities for hard-earned savings to be depleted long before retirement age has therefore increased significantly.

This means that the commonly accepted member lifecycle used to design fund benefits has become outdated. Ignoring these lifestyle changes can jeopardise the welfare of members and their families.

Unfortunately, trustees have very little direct control over what members do with their accumulated savings on withdrawal. However, if members do not reinvest their money in an appropriate fashion, they could land up with only a small fraction of what they could have had at retirement.

It is estimated that changing jobs at age 40 and failing to reinvest, or preserve as it is called in the industry, could cost members half of their income at 65.

Many members may simply be unaware of the dangers of not preserving or be unsure of how to preserve. This is an area where trustees need to educate members widely and regularly. An alternative is to consider default preservation, where withdrawal benefits are moved to a tax-efficient and cost-effective investment vehicle when the member leaves unless the member tells the fund that he or she would prefer another arrangement. Again, thorough education and communication is vital.

Death Benefits

Changes in life expectancy rates in South Africa means death benefits are another contentious issue for retirement funds, as the design of these benefits cuts right to the core of what the the purpose of a retirement fund is.

Because contributions to retirement funds are limited, trustees need to decide on the appropriate balance between death and retirement benefits. This can differ widely between funds and will generally depend on the level of contributions made into the fund.

The increase in HIV/AIDS in South Africa means that an increasing number of retirement fund members will not survive until retirement. This raises the question of whether funds should be putting more of their members’ contributions towards increasing death benefits, and less towards retirement savings.

According to surveys, the average death cover of a retirement fund in South Africa is 3x annual salary. 45.9% of funds have death benefits of 3x annual salary or less and only 4.1% give benefits of more than 5x annual salary.

The graph below depicts the amount of cover that is needed at various life stages, over and above the value of retirement savings, in order to provide sufficiently for 3 dependents in the event of the death of the member.

Even assuming that the member has preserved his retirement savings throughout, it is clear that, the average death cover of 3x annual salary is not sufficient for retirement fund members of virtually any age.

 (Click on image to enlarge)

One way to increase the level of death cover, without increasing the costs or decreasing the amounts that are allocated to retirement savings, is through an annual re-broke exercise. All retirement funds should be trying to get the best death benefits for their budget by shopping around regularly.

Another increasingly common problem that trustees face is in the actual payment of the death benefits.

Higher divorce rates and complex family structures make investigating the financial and family lives of each deceased member increasingly daunting and Trustees face a legal risk if they don’t pay a justifiable amount to each of the right people.

Most funds would benefit from using a structured or scientific approach that demonstrates that the Board of Trustees have applied their minds properly to the apportionment of these benefits.

The lesson here is that a retirement fund’s benefit design needs to be constantly reviewed in line with changes in the way people live their lives in order to ensure members needs are still being met.