It pays to stick with your pension fund

“If you don’t preserve your benefits when you leave a pension fund it’s the equivalent of your younger self taxing your older self!” says Old Mutual actuarial expert David Blecher. He was presenting at the Old Mutual Actuaries Breakfast held in Johannesburg last week. It’s one of the most fitting descriptions of the impact of ill-discipline in retirement saving we’ve ever heard. And hopefully the reference to the hated revenue collection services will make us think twice before withdrawing benefits when we change jobs pre-retirement.

The working environment is constantly changing

This presentation is important because of the changing employment environment. Our parents were probably the last generation who worked in the ‘job for life’ world. They would start with a large company after varsity (or in some cases school) and work their way up the ranks for the next 30 to 40 years. It’s this progression that the textbook pension fund plan is designed for. You would start saving at around 25-years of age, stay with the same fund until the mandatory retirement age of 65-years, and retire with an income replacement ratio of between 75% and 85%. Blecher says that an income replacement ratio in excess of 55% is usually sufficient to maintain an acceptable living standard in retirement. He presented an upward sloping graph to show how the accumulated credit in a fund grows over time under this scenario.

But things have changed. Today’s up-and-coming graduate knows that he has to job hop to get ahead in the dog-eat-dog corporate environment. Professionals typically change jobs between three and four times before finding their niche. Blecher illustrated a typical situation where an individual changes jobs four times (approximately every seven years) in his working life. If this individual withdraws 50% of his retirement benefit each time he changes jobs his replacement ratio at retirement is only 33% (compared to the 75% to 85% sketched earlier).

Pension fund members who fail to preserve their pension funds when they change jobs are at high risk of retiring with insufficient funds. “Taking cash is the path of least resistance,” says Blecher, adding that many people make the mistake of not seeking professional financial advice. He says too many people who are unsure about what to do when they move jobs consult human resources or ask friends for advice. These people aren’t trained to deal with questions like debt repayment versus preservation. He also warns that it’s impossible to preserve with a broker. Thus the best way for fund trustees to handle the early withdrawal problem is through education (within the fund) or by implementing an automatic preservation option.

Will automatic preservation win the day?

Here’s a possible solution. Blecher says fund members should be given the choice (prior to exit date) to indicate whether they want to preserve, transfer or withdraw their money when they exit. If they don’t select an option the default will be to preserve – i.e. automatic preservation. The kicker is that members can make one withdrawal from a preservation fund, which gets around the problem of members subsequently demanding cash where automatic preservation took place. Blecher believes this option will work because members aren’t locked in, can avoid unclaimed benefit tax and have more time to make decisions. The experience suggests most people will simply stick with the default decision, resulting in less wastage of valuable pension savings.

One of the attendees asked an interesting question. They said it was fine and well to create the so-called default preservation option – agreeing that preservation was essential – but wanted to know how the funds should be preserved without input from the member. It would be up to the trustees of each pension fund to make the call, said Blecher, adding that once the funds have been preserved the trustees aren’t legally obliged to check up on them. Blecher suggests the funds be preserved according to the latest fund mandate and urged fund trustees to keep tabs on it going forward. “Obviously each fund will have to develop their strategy,” he said.

What trustees should do in 2009

You must “encourage people to preserve” says Blecher. He suggests using the above scenario to illustrate the impact of early withdrawal on retirement savings as a starting point. If you started saving at 25 and take cash at 35 you ‘lose’ 33% of the total pot available at retirement. This damage is compounded if you take a withdrawal later in life. If you withdraw half of your benefits at 40 your pool shrinks by half by retirement. This accelerates to 60% at 45 and 80% at 55. And of course the damage is magnified if you withdraw cash two or three times through your career.

Blecher has plenty of advice for trustees. He suggests they have an annual plan in place, that they check cover levels when they re-broke, that they consider the need for a death benefit allocation model and do their homework around beneficiary funds. And most important – that they educate “widely and repeatedly on preservation.” He also suggests implementing an automatic preservation option on funds.

Editor’s thoughts:
The problem with early withdrawals from pension funds is we only notice the damage when it’s too late. There’s no way you can make up for the shiny sports car you bought after quitting your second job when you’re in your 60s. Do you struggle to convince your clients to preserve their pension funds when they change jobs? Add your comments below, or send them to [email protected]