The latest – and exemplary – research by retirement fund services provider Alexander Forbes once again highlights the shocking failure of most members of retirement funds to achieve financial security in their later years.
The research indirectly places a major question mark over the government’s failure to move ahead with much-needed retirement fund reforms, in particular reforms aimed at forcing employed people to save for an income in retirement and to preserve their savings. It is a disgrace that ideological arguments have delayed these reforms.
The focus needs to change to address the real issues as soon as possible, because many of the other issues being argued make very little difference to most retirement fund members.
It is worth looking at some of the causes of the low level of retirement savings in South Africa.
In the 1990s, when employers moved helter-skelter from defined benefit to defined contribution funds, little attention was paid to the risks this posed to retirement fund members.
Trade unions (which are now rethinking their initial wisdom) welcomed the move to defined contribution funds, because it resulted in the creation of trade union-controlled retirement funds; employers welcomed the move because it reduced their risk in having to meet a defined pension obligation; and the financial services industry and its product floggers saw the move as a new source of great profits.
In addition, many employers used the opportunity afforded by the move to stop providing members with post-retirement medical scheme benefits.
Defined benefit funds, together with post-retirement medical scheme benefits, meant that members who stayed with the same employer for longer periods than is now the case faced fewer risks. Members knew they would receive:
* A pension based on how much they earned and how long they belonged to the fund. The employer in effect guaranteed the pension.
* A death benefit that would be paid to their dependants if a member died before retirement, based on what a member could expect to receive at retirement.
* A disability benefit if they were unable to work because of illness or injury, based on their income.
u A subsidy for post-retirement medical scheme membership.
The main downside was that if members (and their spouses) died early in retirement, no or very little residual amount was paid to their heirs.
All this changed with the introduction of defined contribution funds and the scrapping of post-retirement medical scheme subsidies.
Innocent and naïve retirement fund members, who also started to change jobs more often, were exposed to a whole range of risks. These included:
* The risk of not having saved sufficient money for retirement, because only the contributions of the member and the employer (and not the member’s final benefit) are defined.
An employer is under no obligation to make up a shortfall in retirement savings. And employers, who are no longer at risk, have withdrawn more and more from ensuring that employees retire financially secure.
* Death and disability benefits that are often inadequate.
Death benefits are generally based on your accumulated retirement savings plus an insured amount that is normally two or three times your annual pensionable salary. Disability benefits are generally based on a percentage (typically between 50 and 75 percent) of your pensionable salary.
Younger fund members, particularly those with greater financial obligations, are unlikely to have accumulated sufficient retirement savings to meet the needs of their dependants on death or those of themselves and their dependants should they be disabled permanently and unable to work.
* Purchasing an annuity. In most cases, a defined benefit fund seamlessly provided its members with a pension at no cost. But with a defined contribution fund, you have to choose a pension, normally by selecting a product from the wide range of options offered by the financial services industry. The purchase of a pension comes at a cost, which reduces your pension.
Initially, the financial services industry hard-sold investment-linked living annuities (illas). Little consideration was given to the investment risks the pensioner had to take or what constituted a sustainable drawdown rate.
Guaranteed annuities were disparaged, because, in most cases, they pay out only for the life of the annuity holder and his or her spouse.
The problem of choosing the wrong pension was heightened by badly skilled product floggers more interested in higher commission structures from the product providers than in serving the interests of pensioners.
Over the years, the problems of the incorrect or inappropriate management of the risks of defined contribution funds have become increasingly evident as more and more pensioners have been left destitute.
As John Anderson, the head of institutional strategy at Alexander Forbes, points out, it is not defined contribution funds that are the cause of the problems. It is that members of these funds tend to make wrong or inappropriate choices without understanding or knowing the consequences, he says.
A bad outcome can also be achieved by a defined benefit fund member who, for example, does not preserve his or her benefits on changing jobs.
Some action has been taken, such as the requirement that financial advisers have more (but still not sufficient) skills and that illa drawdown rates are better controlled by product providers.
Previous research, particularly by Alexander Forbes, has shown that, especially past the age of 70, guaranteed annuities are a far better option for most pensioners, slowly making this preference more popular.
The latest Alexander Forbes research highlights that the risks of defined contribution funds have been exacerbated by too many retirement fund trustees focusing too much attention in the wrong direction instead of ensuring that members understand the very purpose of saving for retirement so that they do not face poverty in retirement.
Alexander Forbes is convinced that, in the absence of legislative changes, some of the problems associated with inadequate retirement savings can be addressed if both trustees and employers focus on the key objective of their retirement-funding arrangements, devise strategies to address the main issues that affect the achievement of that objective, measure the progress towards achieving the objective, have appropriate defaults in place, provide relevant and targeted communication, and do more to educate members to ensure they make appropriate decisions.
In effect, it also means that financial advice and access to it must be improved. This does not mean that retirement funds must provide advice but that members should be given access to, or be encouraged to seek, advice.
In the meantime, you, as a retirement fund member, need to realise that you face an 81-percent risk of a poverty-stricken retirement – mainly because of your own behaviour. You need to establish today where you are with saving for retirement, and then you must do something to make up any shortfall this year and next year and the year after that. The sooner you take action, the easier it will be to avoid disaster.