Can replacement ratios and retirement reform coexist?
The further the retirement fund industry progresses on the road to a National Social Security System (NSSS) the more questions will be asked. Many of these questions were raised at Sanlam’s 2008 Employee Benefits Symposium held in Johannesburg on 18 June
Unravelling a complex set of challenges
NSSS is difficult because of a number of South African economic realities. Masilela listed these as low/variable incomes, high dependency ratios, excessive costs, variable investment performances, increasing longevity and a shift to defined contribution funds. He suggested one way to assess the country’s retirement landscape would be to look at the desired replacement ratio. This ratio expresses the percentage of a person’s final salary in order to maintain living standards in retirement. If your final salary was R800 000 per annum and your replacement ratio is 50%, then you’re happy that R400 000 per annum at retirement is enough.
The challenge for government is twofold. First they have to determine a replacement ratio that makes sense for the citizens of South Africa. And second they must implement the NSSS in such a manner that enough savings exist to ‘fund’ the chosen replacement ratio. Masilela notes that developed economies generally have lower replacement ratios, with the OECD member countries aiming for 56% while countries in the Middle East / North Africa are closer to 75%. But comparisons are fraught with difficulties. The reason is that income plays a massive role in determining what replacement ratio to target!
These differences are demonstrated by the World Bank’s guidance for replacement ratios. Regardless of the income measure used, the proposed target replacement ratio for low income earners is always lower than that for middle and high income earners. So a low-income earner would target 81% (say) while a high earner would target 78%. The SA government has an extremely bold plan to target a replacement ratio of 40%!
Time is your ally and your enemy
The most valuable lesson from Masilela’s presentation is that time is both your ally and enemy where retirement planning is concerned. The more time you have to prepare, the better. With each year that you delay your retirement savings plan the added provision you will have to make in the remaining years climbs exponentially. And before you know it achieving even the most basic replacement value is impossible.
To achieve a replacement ratio of 40% with 35 years to retirement you have to save 12% of your gross salary. This increases to 15% with 30 years to go, 19% with 25 years to go and 35% with 15 years to go. If you’re intent on getting to 85% then you have to save 23% of your gross for 35 years. This increases to an unmanageable 65% of growth if you delay saving until 15 years before retirement. We’re sure these numbers will make you sit up and take notice. Don’t delay! Sit with your financial adviser as soon as possible and make sure your retirement provisions are on track.
The danger of ignoring non-retirement fund savings
Industry statistics suggest that South African savers currently maintain average replacement ratios of between 15% and 38%, depending on how long they remain invested. This information is based on Sanlam numbers and doesn’t account for other retirement savings vehicles. Similar data from Alexander Forbes suggests the average replacement ratio is less than 28%. Whichever data set you look at it appears retirement provision is far too low. And that suggests that the current NSSS proposals might be too ‘soft’. The NSSS proposes between 10% and 16% of gross salaries go toward retirement funding. If we strip out a risk benefit portion (of say 3%) and cost portion (of 1%) then best case we’d only be contributing 12% to retirement funding. This is well short of the 22% saving required to achieve Masilela’s ‘ideal’ replacement ratio of 60% over 30 years!
Each time pension fund reform is discussed it seems we’re closer to a final system. Right now the four-pillar system of social assistance, social insurance, compulsory retirement savings and voluntary savings seems entrenched. It just remains to thrash out the finer details. Masilela said it was comforting to know that government wasn’t going to implement reforms using a “big bang” approach. The 2010 deadline is not a line drawn in the sand; but rather the industry will witness a gradual implementation of the system with due attention to the problem of integrating the ‘old’ with the ‘new’.
Editor’s thoughts:
Sanlam’s Employee Benefit Symposium provided plenty of food for thought for retirement funds and their members. It seems the replacement ratio issue is a complex one which cannot be applied across country borders – or even across different sectors of a single economy. We’d love to hear some of your thoughts on the issue of replacement ratios. What percentage of your final salary do you expect to earn when you take retirement? Add your thoughts below, or send them to gareth@fanews.co.za
