Retirement Reform will take time

Numerous issues still to be ironed out

Given the complexity of the debates currently taking place, a speedy resolution to the retirement reform process is unlikely, says Christo Terblanche, Director of Allan Gray Life Limited.

“While we are supportive of the broad objectives of retirement reform, we caution that the devil is likely to be in the detail,” says Terblanche. 

Retirement fund reform refers to the way the retirement system in South Africa is being changed. The process began over 10 years ago with a series of reviews of the tax system and is now firmly in the spotlight as stakeholders try to bed down the best way forward. Broadly speaking, the changes aim to increase participation of all South Africans in the financial system (through an increase in savings) and improve the existing social security net for the vulnerable and poor.

Terblanche says the range of objectives policymakers aim to meet is diverse, and includes poverty alleviation, increasing savings, limiting the impact on the state’s purse, capital market stability, increasing public confidence in the retirement fund system, and labour market incentives.

“These are all hefty topics in their own right. It is no surprise therefore that retirement reform has become a very complicated, sensitive and heavily-debated subject,” he says.

Typically, a retirement funding system revolves around four pillars:
1. A government-funded social security pillar to provide a basic public grant system as a safety net against poverty in old age.
2. A primary mandatory retirement savings and risk insurance pillar to provide basic retirement and risk benefits.
3. A secondary mandatory savings pillar provided by the financial industry to ensure adequate income replacement.
4. Supplementary voluntary savings above these levels.

The main purpose of the primary mandatory retirement savings pillar is to increase the coverage of retirement funding and improving living standards in retirement. Every employed person, and possibly those in informal employment as well, will have to contribute a percentage of his or her salary. Debates around this pillar include the method of funding, i.e. whether contributions will build up to benefits over time for the current generation of funders (a funded system) or whether contributions now will fund the pensions payable now (pay-as-you-go system), the approach to tax, the level of contribution, whether the benefits will be defined or based on the accumulated contributions, and whether costs will be regulated or competition will be allowed.

It has largely been agreed that fund members will not be able to cash-out their accumulated contributions early, but this is not without controversy. People who lose their jobs, for example, might need this money to survive today.

There are also issues around investment management mandates. “It is likely that the investment management will be outsourced to the private sector, but there is uncertainty about many matters such as regulatory rules that may apply or any cost structures,” says Terblanche.  Another debate is around the extent to which choice of underlying investment options will be made available.

The secondary mandatory savings pillar to be provided by the financial industry aims to ensure adequate income replacement – a technical term that summarises how well your retirement income will replace your salary / earnings. In other words, can you maintain your standard of living after you retire?  Important factors that inform this include:
• How much money you put in
• How much money is eaten away by costs
• How much your money grows
• How long you save
• How much you take out and when (‘leakage’)

Then, in terms of the voluntary savings pillar, there is a debate about whether there should be a tax incentive and, if so, up to what level.  Right now members can get a tax break on up to 15% of their non-retirement funding income, with no upper limit.  Terblanche says it is likely in that in the new regime an upper limit will be applied and there will be harmonisation of the upper level for the tax break and the level at which there are compulsory contributions.

Regarding what you get at retirement, Terblanche says there is a big push towards reducing lump sum withdrawals and rather requiring everyone to take out an annuity that would provide an income over the long term.  “The key question is the extent of flexibility that will be allowed within annuity options to cater for individuals’ unique needs,” Terblanche concludes.