The transition from defined benefit to defined contribution pension funds has moved the onus of ensuring a comfortable retirement firmly from employers to employees.
And yet, few South Africans truly appreciate how the decisions on their way to retirement (and thereafter) have a direct impact on their quality of life.
In a defined benefit environment, the employer effectively undertakes to pay employees a pension for life (based on their years of service). The employer bears the risk of worse-than-expected investment returns or higher than expected expenses. In a defined contribution environment (most South African funds fall into this category) the member needs to ensure adequate contributions, a sufficient savings horizon, reasonable fees and choose the appropriate underlying funds to maximise returns.
Currently, only a small fraction of South Africans are able to maintain their standard of living in retirement. Yet, there is a significant risk that an already dire situation could reach crisis mode as people run out of money in a lower return environment and amid greater longevity.
Petri Greeff, RisCura executive, likens the move from a defined benefit to a defined contribution environment to people taking a bus to their destination.
In both environments, individuals buy tickets (make contributions), get on the bus and drive to their destination (retirement). But while the bus company still drives around the members of a defined benefit fund after retirement (pay a regular pension for life), the people in defined contribution funds only drive along till they reach retirement. At that point the bus driver stops and they are asked to leave the bus.
What complicates this picture is the fact that most members in defined contribution funds would have got on and off several buses along the way. They may have cashed in their retirement benefits, may have contributed the minimum level required, and may not nearly have enough funds to buy the car (pension) they need to get around. And yet, they have largely been left to their own devices.
How can the retirement industry ensure that more South Africans don’t have to use a tricycle at that point? Or worse: walk?
1. Fewer choices
Employees are inundated with choices around contributions, funds, asset allocation and annuity options and are often ill equipped to make an informed choice.
While the implementation of the final retirement fund default regulations on September 1 may offer some relief, some funds already argue that one default won’t be sufficient, Greeff says.
Defaults are automatic choices made on behalf of retirement fund members who do not exercise their choices in a given situation.
The intention behind default regulations is correct – the implementation is the problem, he argues.
National Treasury issued the final retirement fund default regulations – an effort to improve the retirement fund outcomes for members by ensuring that they get good value for their savings and retire comfortably – on Friday.
“The regulations require retirement funds’ trustee boards to offer a default in-fund preservation arrangement to members who leave the services of the participating employer before retirement, and also a default investment portfolio to contributing members who do not exercise any choice regarding how their savings should be invested. For retiring members, a fund should have an annuity strategy with annuity options, either in-fund or out-of-fund, and can only ‘default’ retiring members into a particular annuity product after a member has made a choice,” it said.
The default regulations will require that fund trustee boards assist members during the accumulation and retirement phases, which may nudge members in the right direction.
Greeff says financial advisors are supposed to assist members to make appropriate decisions, but this may not always happen.
2. More trustee guidance
Here default annuities will play a significant role – trustees should provide an indication of what they believe the best choices are, Greeff says.
If the bus driver (trustee) stops at the bus stop, he shouldn’t just ask the member to get off and choose a car (annuity), but rather suggest a reliable, fuel-efficient vehicle that has been tested.
“Trustees really have to apply their minds to put a default annuity in place that is in line with member needs.”
Default annuities are often much more cost effective as the investment managers are the same during the pre- and post-retirement phases and institutional rates apply, he adds.
Trustees can also help members to maximise their replacement ratio (their retirement income as a percentage of their final salary), but are not responsible to provide members with a 75% replacement ratio where they only contributed to the fund for a portion of their working life. Yet they can make a valuable contribution to build an investment strategy that can take members from 50% to 65% (for example), he says.
3. Appropriate communication
Communication about market movements in a retirement context is often problematic, Greeff argues.
If a pension fund member reads that markets dropped 4% in a particular month, the broader context may be lost completely.
It is similar to telling someone that two fingers of a KitKat chocolate contain 439 kilojoules. Without a fairly good knowledge of dietary requirements, this information is meaningless. However, the packaging also notes that someone should exercise for 20 minutes after enjoying two fingers of KitKat.
This immediately puts someone in a position where they can make an informed decision about consuming the chocolate, Greeff says.
Talking about replacement ratios is similar to talking about kilojoules without the necessary context, he argues.
“Member communication is too technical and yet we expect members to make the right choices.”
Rather, communication should inform members how a small increase in contribution can reduce the period they need to save for, or that a year of bad performance may require them to work longer before they can retire, he suggests.
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