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Retirement savings outcomes remain in the doldrums despite regulatory push

07 July 2020 Gareth Stokes

The 2019 Alexander Forbes Member Watch ™ confirms that South Africa has made little progress on the road to sustainable retirement outcomes for fund members in the formal savings environment. The latest report, which is a quantitative assessment of the more than one million retirement savings accounts administered by the financial services firm, shows that fewer than one in 12 fund members will achieve a replacement ratio of 80% or better in retirement. It offers valuable insights about member decisions insofar contributions, investment choices, and retirement age, among other factors.

Getting to grips with the RR

The replacement ratio is the preferred measure used by the retirement savings industry to assess whether retirees are achieving sustainable incomes in retirement. The ratio represents a retiree’s income in his or her first year of retirement expressed as a percentage of his or her final pre-retirement pensionable salary. The phrase ‘pensionable salary’ is important because many retirement fund members receive benefits that are not part of their pensionable salary. The replacement ratio for someone with a pre-retirement salary of R50 000, which included R5 000 in non-pensionable benefits, would thus be determined using the R45 000 per month pensionable salary only. In this example a 50% replacement ratio would be equivalent to a R22 500 post-retirement income. 

There are countless factors that financial advisers and their clients must know about the formal component of their retirement funding journeys, whether as members of a pension or provident fund or retirement annuity. These include the overall level of contributions to the retirement funding vehicle; the administrative expenses and risk premiums deducted from said fund contributions; the investment fees and returns on the member’s investment portfolio; the member’s salary progression; and the impact of preservation on the retirement savings journey. Factors that have a major impact at retirement centre on how much cash is available for conversion into a pension and the prevailing annuity rates. The Income Tax Act requires that retirees use at least two thirds of their accumulated capital to purchase an income upon retirement. 

A dismal replacement ratio experience

What does the 2019 Member Watch reveal about some of these measures? First, and perhaps most importantly, it shows the average monthly contribution to retirement funding to be just 12,3% of gross pensionable salary. The total contribution is slightly higher, at 14,2%, but includes administration expenses and deductions for life, disability, and other group risk benefits. There was a significant skewing towards the employer, who contributed on average 9,2% of the pensionable salary per month versus only 5% from the employee. The retirement fund members assessed for the report achieved an average actual replacement ratio of just 26,2%. 

Alexander Forbes projects a 40,5% average replacement ratio for all fund members considered for the 2019 Member Watch provided they save adequately, exit their funds when expected, and preserve retirement benefits whenever necessary; but warns that such rigorous adherence is unlikely. “The biggest factor affecting retirement outcomes remains the lack of preservation,” said Vickie Lange, Head of Best Practice at Alexander Forbes. She observed that only 8,8% of members opted to transfer their fund balances into a preservation fund when the opportunity presented. Statistics also point to a clear correlation between the amount of accumulated retirement capital and the likelihood of it being reinvested. 

As a rule of thumb, you will need 12 times your annual salary to ensure 75% of your pre-retirement pensionable salary as an income in retirement, with most experts suggesting that 14 times is preferable. An individual would have to contribute about 17% of his or her gross pensionable salary for a period of 40 years to achieve this. Those who embark upon the savings journey too late face an uphill battle to reclaim the lost ground due to missing out on the benefits of time in the market and compounding. Alexander Forbes offered two examples to illustrate the difficulty in catching up by either increasing monthly contributions or delaying retirement. In the former case, someone starting his or her retirement journey at age 40, and contributing 17% of gross pensionable salary per month, would only achieve a replacement ratio of 38% by age 65. In the latter case, you could double your replacement ratio by delaying retirement from age 55 to 65 years. 

Finding solutions to lacklustre outcomes

How can employee benefit consultants and financial advisers improve retirement outcomes? According to Alexander Forbes there is a need to correlate advice with key inflection points in the retirement fund member’s financial journey. “We need to talk about issues and solutions nearer the decision point,” said Lange. Another important consideration is that members shoulder a part of the responsibility. “The member must take responsibility for their financial wellbeing and there is only so much that the other stakeholders can do,” she said. 

Belinda Sullivan, Principal Consultant of Multinational Consulting and Best Practice at Alexander Forbes said there was a growing need to instil financial discipline among younger savers. Principle among these requirements is to illustrate the future value of small amounts of money; to highlight the trade-off between less take-home pay early on in one’s career versus the benefit of a larger accumulated sum at retirement; to illustrate the power of compounding over 40 years; and to encourage preservation. It is also important that employees establish their financial goals as soon as they start working. 

The financial services industry has considered various initiatives to improve retirement funding outcomes, most notably through the September 2017 implementation of default regulations, which had to be fully implemented by 1 March 2019. There were three main components to these regulations, namely default investment portfolios per regulation 37; default preservation under regulation 38; and default annuities as set out in regulation 39. The default preservation regulation meant that someone who resigned from a retirement fund, regardless of the reason, would have to inform the fund what to do with his or her accumulated capital, or else the capital defaulted as a paid up amount in the employer fund. Other options were to take the amount in cash, to transfer to another retirement fund; or to transfer to a retail preservation fund. 

Default preservation still simmering

The expected positive outcome of the implementation of default regulations does not appear to have filtered through to the latest Member Watch statistics. “We were a bit disappointed when we completed our assessment; but it is still a bit early to see the impact,” concluded Lange. The firm is closely monitoring its funds to quantify the effect of default regulations and will report on any trends that exhibit in due course. 

Writer’s thoughts:
The 2019 Alexander Forbes Member Watch ™ makes for interesting reading. Retirement fund members are, on average, hopelessly behind in accumulating enough capital to secure sustainable incomes in retirement. According to the report, the average 55 year old has only saved two times his or her annual earnings, when six times is required. What advice do you give to clients who have fallen this far behind their retirement saving target? Please comment below, interact with us on Twitter at @fanews_online or email me us your thoughts [email protected].

Comments

Added by Gareth Stokes, 08 Jul 2020
Thank you for your insights Harley. We see a media storm every few years when an adviser tries to exit these legacy RAs, only to discover dismal investment performance and massive exit penalties.

There are some new entrants trying to reduce fees; but one wonders whether certain products should rather be rebuilt from the ground up, incorporating TCF and consumers’ financial objectives.
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Added by Harley Ritz, 07 Jul 2020
The industry lacks transparency & flexibility to the detriment of retirees - i.e. High Platform Fees charged by Insurers, lack of flexibility to investment portfolio options, Regulation 28 - An RA taken in 1989 is all in favor of the Insurer with huge penalties for changes made and being forced to contribute premiums to age 65 - The industry is in Chaos with no protection for Policyholders from the FSCA as the Insurers call all the shots !!!
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