Retirement fund reform in South Africa

In a conscious effort to alleviate the poverty levels of those reaching retirement age, as well as the prudent management of retirement fund monies accompanied by sound governance structures, the National Treasury recently released its second discussion paper on "Social Security and Retirement Reform".

Commenting on the paper, Krishen Sukdev, consulting actuary for Aon Employee Benefits, says that while the finer details are still to be announced, the paper takes the first step towards reform with the proposed establishment of
a cost-effective National Social Security Fund.   The Scheme would house
mandatory contributions based on income up to a threshold level (for example R60 000 per annum).  "In establishing this Fund, the Government is mainly targeting lower income earners who previously had little tax incentives to save for retirement. A wage subsidy to assist low income earners is also on the cards,"he says.

In drafting the proposals, the National Treasury has considered the various challenges facing retirement fund savings, including:

* Too few people are saving for retirement (especially those who are self
employed, in semi-formal employment or with irregular income)
* For those who are saving, there is a need to maximise the proportion of
contributions going towards retirement (by for example minimising fees);
* Investment returns must be maximised and subject to an acceptable level of
risk;
* Monies in the retirement funding net must be preserved on changing jobs;
* The savings at retirement should be utilised to purchase an income for
life, although it is recognised that a portion should be available as a lump sum.

Sukdev says a retiring individual currently has access to three potential sources of income: social security benefits from the State; proceeds from Retirement Funds (Industry and Occupational Pension and Provident Funds); and individual savings including individual retirement annuities.

"Social Security Benefits are financed on a pay-as-you-go basis where current government revenue is used to pay current benefits. Other retirement savings are usually on a funded basis, where monies are set aside in advance to fund for retirement benefits," says Sukdev. "To assist this process, the government provides tax incentives to companies and individuals to contribute towards retirement savings. The harmonisation of the taxation treatment of contributions, build-up of assets and benefits of the various retirement funding vehicles will simplify matters. The abolition of the Retirement Fund Tax from 1 March 2007 is also a step in the right direction and assists those saving for retirement. "

Sukdev cautions that although social security benefits may alleviate poverty to some extent for those in retirement, it will not in most instances provide individuals with income that can assist them in maintaining the lifestyle they were accustomed to prior to retirement. "Hence individuals will have to provide for themselves from a combination of personal savings as well as the income from retirement funds," he says.

The Government Fund will be Defined Contribution, which means the investment risks are still with the members. There are still various important decisions that would need to be made relating to the investment of the monies, such as:
* Who manages the assets?
* What investment choices are available to members?
* Will there be any guarantees?
* Who will select the default portfolios for those who do not wish to choose
their investment portfolios?

Importantly for individuals, there would be portability of these savings on switching jobs.

"Although Government is yet to map out the role of the private sector in the operation of the National Social Security Fund, savings and risk provision through retirement funds and individual vehicles will be necessary to supplement income in retirement and risk provision," says Sukdev. "Financial advisers will have a key role to play in assisting individuals identify their shortfall in savings and identify appropriate savings mechanisms."

Government proposals come against a background of low savings rate, leakage in savings by individuals cashing in their benefits when switching jobs, as well as erosion in confidence in the current retirement funding infrastructure. As a result, government action is necessary, especially in the short-term, to counter-balance this erosion in confidence due to the negative publicity regarding excessive charges, allegations of secret profiteering, lack of transparency, conflicts of interests and even allegations of fraud.

"In the long-term, the government is aware that the more individuals provide for themselves, the less likely they will be impoverished in retirement and also they may become less reliant on the state for social security benefits although who exactly will qualify for state old age pensions is still to be clarified," says Sukdev.

Also importantly, government needs to set a benchmark for success. How many members does the National Social Security Fund need to attract, and what income at retirement should they target?

"Although Government has not published the finer details of the National Social Security Scheme, we do at least have a good indicator of governments'
concerns and plans" concludes Sukdev.