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Data made available by the Financial Services Board in May 2014, suggests that the total membership of umbrella funds across five of the largest insurers in South Africa is in the region of 1.2 million with the total assets held on behalf of the members being approximately R136 billion. This means that on average each member has approximately R120 000 in their retirement savings account with that particular umbrella fund. Although this is an astonishing low amount, we must consider members' average age as well, which would be around 40 years old for a working person.

Bringing this closer to home, the average FundsAtWork Umbrella Fund member has an average fund credit of R130 000. Taking into account that their average age is approximately 40 years, the amount of retirement savings per member is extremely low. When calculating the expected replacement ratio for the average member, it is clear that the retirement time bomb is a reality for most. Members' apathy toward retirement fund planning will result in "the luxury of eating pet food” and for some it may remain a pipe dream. The expected replacement ratio gives an indication of whether the member will be able to buy a sufficient income stream at retirement to maintain their standard of living until death. The replacement ratio is reflected as a percentage and is calculated by dividing the expected annual income stream after retirement by the last annual salary before retirement. It is generally accepted in the industry that targeting a replacement ratio of at least 75% is adequate if we assume that your pensionable salary is in line with your total cost to company and you are familiar with all the assumptions made. For example, if your salary is R10 000 per month by the time you go on retirement, the pension that you should aim for should not be less than R7 500 per month (75%). The expected replacement ratio calculation is based on assumptions and should be reviewed at least annually.

The expected replacement ratio for most FundsAtWork members is between 30% and 40% if we assume that:

• The average member remains employed and retires at 65;

• Contributes approximately 10% of their cost to company (CTC) towards retirement;

• Remains invested in an investment portfolio that consistently outperforms inflation by 4% per annum;

• Preserves assets if they change jobs; and

• Annual salary increases are 1% above inflation.

**What does it mean having an expected replacement ratio of 30%?**

In our example we assume that our average member is a male buying an inflation linked annuity of which the growth will keep pace with inflation and that he buys the annuity for his entire life where the longevity risk is taken by the service provider. This means that his investment might be exhausted during his retirement but that the insurer will assure him of an annuity income for as long as his lives.

If we assume that the member in our example earns an annual CTC of R250 000 just before retirement and annual deductions including only retirement fund contributions of R25 000 (i.e. 10% of CTC) and tax of R56 250 (if we assume a tax rate of 25%) his annual income is R168 750 or **R14 063** per month.

Having an expected replacement ratio of 30% implies that he can only buy a monthly annuity income of **R6 250** **per month** before tax (i.e. 30% of annual salary of R250 000). This however assumes that his retirement fund savings with FundsAtWork is his only provision for retirement, which is a fair assumption for most. Employer-sponsored benefits are often the only form of retirement savings and insurance cover individuals have which means that outside of their formal retirement savings planning, individuals don't make supplementary provision.

To avoid downscaling substantially after retirement, retirees often purchase living annuities. Living annuities allow retirees to choose an appropriate drawdown rate which means you can take between 2.5% and 17.5% annually as an annuity income to try and maintain your standard of living after retirement. This results in drawdown rates well above the recommended level of between 4% and 6%, which will reduce retirement fund savings at a rapid rate if the underlying investments underperform. With living annuities retirees run the risk of their investments being exhausted during retirement.

Again, using the example of our average male member, if he buys a living annuity and withdraws an amount that is approximately 75% of his salary (i.e. R250 000* 0.75% = R187 500) to maintain his standard of living he will have to select a drawdown rate close to the maximum allowed of 17.5%. If we assume that his underlying assets grow by inflation plus 4% per annum (10% in nominal terms before inflation assuming an inflation rate of 6%) his retirement assets will reduce at an alarming rate because his withdrawal rate is more than the anticipated growth. When he reaches his maximum withdrawal limit of 17.5% allowed, which will happen within approximately three years after retirement his annual income will start reducing at a worrying rate with the possibility of his annual income halving ten years after retirement. While maintaining the maximum drawdown rate, the average member will reduce his income to such an extent that they will become reliant on their friends and family or be forced to sell their house or other assets simply to get by.

It is a well-known fact that people generally live longer. Running out of retirement savings only years after retirement will have disastrous consequences and many will end up in this dire situation – this is then when the "luxury of eating pet food” could become a pipe dream. This is exactly why the Government is adamant about P-day, the day on which preserving one's retirement savings will become compulsory when changing jobs.

Only we as South Africans can change the outcome and individuals should seriously start taking ownership of their retirement fund investments to change the expected dismal outcome. Every member of a retirement fund should contact their financial adviser and ask them to review their investment strategies. Those who are not members of a retirement fund through their employers should contact their financial advisers for assistance on how to start saving. As an immediate action point, we should all give up on the luxuries and increase our retirement savings contribution rates.

To see data made available by the Financial Services Board in May 2014 click here.

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