New proposals could give dismal pension numbers a big boost

Laura du Preez | 15 October 2021

Laura du Preez has been writing about personal finance topics for more than 20 years, including eight years as personal finance editor for two leading media houses.

Failing to preserve your retirement savings when you change jobs is the single biggest reason why people retire with too little money.  Proposals put forward by National Treasury could, however, boost South African’s pensions by two to three times.

This is the conclusion arrived at by actuaries who have crunched the numbers, or modelled the effect, of National Treasury’s proposals to force retirement fund members to preserve at least two thirds of their savings at all times. 

The draft proposals have yet to be released, but it is expected that what is dubbed as a “two-bucket” retirement savings system, will result in a small percentage of what you contribute being used for one “bucket” that you can access as emergency savings.

The remaining larger portion of your contribution – anything from 75% to 90% - would be untouchable until retirement.

The proposals are seen as a smart move not only by the Actuarial Society of South Africa’s Retirement Matters Committee, but also by the country’s largest retirement fund administrator.

Alexander Forbes this week presented its Member Insights research on the 1 million members whose retirement money it administers.

Failing to preserve the biggest problem

John Anderson, the executive for investments, products and enablement, says the findings show that a lack of preservation is the single biggest factor leading to poor pensions at retirement.

In addition, Alexander Forbes found that while some members have financial problems and there was an increase in the number of members who defaulted on repaying their debts last year, financial pressure was not the main reason why members failed to preserve.

Anderson says it seems a lack of understanding, apathy or the administration involved in preserving retirement money is the main reason.

Some of this has been addressed by the introduction of regulations obliging your retirement fund to preserve your savings in the fund by default when you leave an employer. If you want to take the cash, you can, but you have to request it and receive counselling about the impact.

Two to three times more pension

However, the latest proposals by National Treasury forcing you to preserve could have a significant effect and increase the pensions members can afford to buy at retirement by two to 2.5 times, Alexander Forbes’s modelling shows.

Retirement funds are typically designed to deliver pensions of between 60 and 75% of your final salary if you save for long enough.

If current members continue to add to their savings as they are currently in funds administered by Alexander Forbes, they are expected to retire with around 40% of their final salaries. However, because many fail to preserve, retirees are actually only achieving pensions of around 28% to 31% of their final salaries, the administrator’s member data reveals.

Being forced to preserve two-thirds of your savings at all times could increase members’ pensions to 60% of their final salary – much closer to the ideal 75% of final salary that those who save for long enough and preserve all their savings can achieve.

The Actuarial Society’s modelling also suggests that forcing you to preserve the bulk of your retirement savings could result in a significantly higher monthly retirement income for pensioners, whose retirement savings would benefit from the power of compounding. It's modelling suggests pensions could triple.

Natasha Huggett-Henchie, a member of the society’s Retirement Matters Committee and the principal consulting actuary at NMG Consultants and Actuaries, says an analysis of fund administrator data shows that more than 80% of retirement fund members cash in their retirement benefits when changing jobs rather than preserving.

Punitive tax rates for withdrawals have failed to deter most people from accessing the cash, Huggett-Henchie says.

She says by taking the cash you prioritise your short-term needs and wants, and sacrifice future investment growth on your savings. Savings made later in life benefit less from the impact of compounding returns. Read more: Why compounding growth is so important?

In addition, withdrawing your savings when you change jobs puts you at risk of double taxation that also reduces the pension you can realise at retirement.

Huggett-Henchie explains that cashing in your retirement benefits before retirement, reduces the tax-free lump sum normally available at retirement. You can only withdraw R25 000 tax free before retirement, but the amount you withdraw also reduces the R500 000 you could enjoy tax free at retirement if you don’t raid your pension savings before retirement.  Read more: Why is withdrawing from my retirement fund a bad idea?

The high cost of withdrawing

Retirement fund provider, 10X recently published a survey of South Africans’ views on retirement savings. The 10X Retirement Reality Report shows that R10 000 withdrawn from your retirement savings at the age of 25 could cost you R115 000 over 50-year period – the 40 years to retirement plus half – or 10 years - of a 20-year retirement. (10X calculated this by assuming you would have earned a 5% return above inflation on the money you withdraw.)

Members of the Actuarial Society’s Retirement Matters Committee say without forced preservation, a member earning R20 000 could change jobs every seven years and withdraw their retirement savings in full each time.

Assuming they only start focussing on saving from age 50 until retirement at age 65, this member will retire with savings able to buy a pension of 15% of their income or R3000 a month (this assumes the member and his or her employer contribute 12% of the member’s income to the fund each month).

If the member takes one third of their savings as a lump sum at retirement, they will only able to buy a pension equal to 10% of their pre-retirement salary amounting to R2000 a month.

Huggett-Henchie says if this same member was forced to preserve two-thirds of their savings at all times, but withdrew the full remaining one third every five years, the member would have enough at retirement to provide a pension of 36% of their final salary or R7200. This would reduce to R6400 if the member took a one third lump sum at retirement.

A member contributing at the same rate, but who doesn’t access their benefits ever, could end up with enough to buy a pension of almost 52% of their final salary (R10 400) if they don’t take a cash withdrawal at retirement, or 32% if they do (R6 400).

Rules for access

Huggett-Henchie says while Treasury has yet to finalise the details of the two-bucket system, the ASSA committee feels strongly that the rules for withdrawing from your retirement fund should not be on the basis of need as this is open to abuse and very onerous and costly to administer.

“Our modelling indicates that forcing the compulsory two thirds preservation actually improves outcomes at retirement, and members are going to find a way to borrow against or spend their one third anyway. Access to the one third should therefore be available to all retirement fund members regardless of need. ”

The 10X Retirement Reality Report shows most of us are in the dark or ill-informed about preparing for retirement – including those of us who don’t plan to retire.

The report shows that around half of us are not saving for retirement and most of us underestimate how long we need to save for.

In addition, many South Africans – especially those just starting their careers - think they won’t retire. The report notes that they fail to appreciate the high unemployment rates in South Africa. In addition, it is impossible to predict that you will always be healthy enough to continue to work in later years.