Six million South Africans contribute to some kind of employer retirement fund. That number may seem impressive at first glance, but when you consider the full picture, it is certainly not.
Four million people are in formal employment but do not contribute to a company retirement fund. Many have made no additional retirement provision in their personal capacity at all.
Add to that the millions in the informal economy and millions more who are unemployed. Then it is clear that South Africa’s potential retirement cost burden seems out of balance. Retirement is a painful period financially for the majority of South Africans. When working people are contributing to an employer retirement fund they may be tempted to believe they are guaranteed to live comfortably in their golden years.
But is it wise to sit back and relax if your retirement fund contribution is deducted from your salary every month? Floris Slabbert, a director at Ecsponent Financial Services, a wholly owned subsidiary of Ecsponent Limited, says this would be foolish. “A simple answer to the question of whether you can rely only on your company retirement fund to fund your retirement, is ‘no’,” says Slabbert.
What are the reasons a company retirement fund may not be enough to see you through retirement?
Not all employees have the option to contribute to a retirement fund
Four out of ten working South Africans earn a “cost-to-company” salary with no benefits package. These millions of workers – most of whom work for small or medium-sized companies – need to make their own provisions for retirement.
Those in the informal sector or self-employed also have to make their own plans. “This is not ideal because the costs of setting up retirement funds and risk cover in your personal capacity are often far more expensive than large employer funds,” says Slabbert. “Having a significant amount saved at retirement age is dependent on discipline throughout one’s working life. Every year that passes without savings, is a year lost. To try make up for the lost opportunity to earn compounded interest over a long period, becomes very expensive,” Slabbert adds.
The costs of managing a retirement fund can be high
South Africa has relatively high retirement fund costs when compared to other countries. With that fact in mind, one then must consider the functions retirement funds perform on behalf of their members.
They collect money from contributors, pay out money to retirees, follow up with beneficiaries and they administer investments. All these services come at a cost. There are a host of factors that influence the relative value of the cost. This includes the size of the fund, whether or not contributions are compulsory, how the assets are invested, and the quality of service rendered, etc.
“The higher the costs of investment, the more pressure on the investment manager to achieve returns that outperform the impact of costs and inflation on your investments,” says Slabbert. “A single percentage point in fees can make an astronomical difference over 40 years.” Some pointers to look out for include the platform fees as well as any administration costs. Note that advisory fees are negotiable and should be evaluated and reviewed annually. Make sure you get the best bang for your buck and don’t be fooled by the headlines.
Ask your financial advisor to break down all fees including the underlying fund costs, especially if your retirement fund makes use of a pooled arrangement.
The level and cost of risk benefits can be high
Most South African pension funds allocate a portion of the income they collect to death and disability benefits. While wellness factors and the improved rollout of antiretrovirals for HIV/AIDS has improved life expectancy, mortality projections indicate that deaths of working age employees will outpace new retirements within a few years.
The average death benefit of a pension fund member is a multiple of his or her annual salary. Disability benefits consist of either a lump sum or the more expensive option where the beneficiary receives a proportion, such as 75% of the salary.
“It stands to reason that the more money goes towards claims, the less will be left for retirement benefits. The cost of risk benefits ultimately negatively affects the performance of the remaining investment assets in the fund,” explains Slabbert.
Investment choices of the trustees
Investment choices make a significant impact on the long-term performance of retirement funds.
All retirement funds must comply with Regulation 28. This means they will invest in funds that carry lower risks. For example, retirement funds may not have an exposure higher than 75% in equities, 30% offshore and 25% in property.
“Many employees have no say over how their investments are managed, such as those who are part of large umbrella funds,” says Slabbert. “On the other hand, there is research which shows that members who do have a say about how investments are managed, often tend for the very conservative and low-risk route.
This introduces a different type of risk. “Managing a fund according to mandate that is too low-risk, will deliver returns below the inflation rate,” Slabbert explains.
Lack of preservation
South African legislation allows employees to withdraw their retirement benefits when leaving an employer.
“A Sanlam Benchmark Study in 2011 found that in their research sample only 2% of people who changed jobs moved their benefit to the new employer’s fund. 9% invested a portion of their pay-out. This leakage has massive negative implications for both individuals and South Africa as a whole,” says Slabbert.
If paying a monthly contribution to an employer fund is not enough to ensure a secure retirement, what else can you do?
“Be wise,” suggests Slabbert. “Age-old wisdom warns against keeping all your eggs in one basket.” Instead, Slabbert suggests diversifying your investments so that you have exposure to different types of savings, investments, platforms and asset classes.
“It would be wise to speak to a financial advisor and build an investment portfolio that spreads your risk and exposes you to the benefits of diverse investments such as preference shares,” says Slabbert. “What you want to do is have as much money saved by the time you retire as possible. You can then supplement the income you will receive from your retirement fund from these extra assets.”
Don’t stop when you retire
Even in retirement, smart investing can, and should, continue. At retirement, you can take one-third of your retirement fund in cash. You will have to invest the remaining two thirds in an annuity fund. You will need to choose between a life or living annuity, or combination of both, based on your individual needs. Then, investing the remaining one-third to supplement your income and hedge your risk is prudent,” says Slabbert.
“Preference shares, again, are a good option because they provide a regular income in the form of a dividend. To manage your returns and optimise your taxable income, you need a good spread and risk diversification. The balance between the income from dividends, and income from annuities that attract income tax, will provide a more balanced outcome. It will also hedge against lower yields from your annuity. This will also require a lower annual drawdown from your annuities.
Capital preservation should be one of your main focus areas. By applying this method, you will not draw on your capital in the form of an income. Instead, you can live off the yields from your investment. Additionally, as the JSE has returned below 5% per annum in the past three years, it is comforting to know you are receiving stable, predictable returns of over 10% per annum. Also bearing in mind that unlike the income from the annuities, which is taxed at your average tax rate, dividend income is only subject to DWT (Dividend Withholding Tax),” says Slabbert. “If you do not have a financial advisor, consider getting one today and take charge of your future.”