Due to this country's vast disparities in wealth, creating a retirement-savings system that will cater to the needs of all South Africans is not simple. However, the key features of what the government wants to achieve are beginning to emerge.
No one will be immune from the effects of the government's reforms of the country's retirement-funding system. The process that is under way will affect every South African, rich or impoverished, as the government tries to find a structure that is sustainable and that is capable of addressing issues as diverse as alleviating poverty and the costs of saving for retirement.
There are almost 2.3 million elderly people in South Africa who each live off an old-age grant of R870 a month. Many more receive pensions that are not much higher. In the main, most people do not have sufficient money on which to retire.
Many of the people who receive the state grant or a very low pension could have done little to save adequately for retirement because they were unemployed for most of their working lives or were employed intermittently and/or at a low rate of pay.
The means test that anyone who applies for the Social Old Age Grant (SOAG) must undergo discourages low-income people from saving for retirement. And the evidence shows that many people will cash in their retirement savings shortly before or when they retire and spend the money on something else so they can qualify for the SOAG.
To make matters worse, many of the pensioners who live on the SOAG use the money to support not only themselves but as many as five dependants, many of whom are unemployed adults.
At the other end of the social spectrum are those pensioners who are not financially secure, even though they earned a salary that would have enabled them to save adequately for retirement.
Research undertaken by Alexander Forbes shows that on average when people retire they receive a replacement rate of only 28 percent from their last fund. Your replacement rate, or ratio, is the percentage of your final pensionable salary that you, as a member of a retirement fund, receive on retirement. Although pensioners may obtain additional retirement income from other sources, such as a retirement annuity (RA) fund or discretionary savings, it is unlikely that these amounts will be significant.
Rowan Burger, the head of consulting strategy at Alexander Forbes Consultants and Actuaries, says the main reason people who could otherwise afford to do so do not retire financially secure is because they fail to preserve their retirement savings.
Instead, when they change jobs they use their accrued retirement savings for other things, ranging from paying off debt to buying a new motor vehicle. There is evidence that some people resign from a job merely to get their hands on their retirement savings.
This destruction of retirement savings is why those involved in retirement reform agree that people who can afford to save for retirement must be forced to do so, and those savings must be preserved for retirement, when they must be used to purchase a pension that will be sustainable until death.
Rob Rusconi, the independent actuary who blew the whistle on the high cost of saving for retirement in South Africa, has been doing extensive research on international retirement saving models.
No country has a perfect system and each country has its unique challenges. And because of the many socio-economic differences within each country, such as disparities of wealth and employment, there is no single solution.
Clearly, the retirement reform process in South Africa is not simple. The government wants to devise reforms to ensure that people who can save for retirement will do so, that those on low incomes will be helped to save and that those who don't have the ability to save at all will be rescued from abject poverty. The latter objective is why retirement reform is no longer the exclusive preserve of the National Treasury under Finance Minister Trevor Manuel, but has been extended to encompass social security.
Selwyn Jehoma, the deputy director-general of the Department of Social Development, points out that social security is not limited to reforming the retirement system. It must include combating poverty through measures such as providing a minimum income, unemployment insurance, access to appropriate disability and death benefits, and ensuring that people who have saved for retirement have made provision for their healthcare costs in retirement.
Five pillars
The World Bank has conducted extensive research to identify how different socio-economic groups in society should be assisted. Its retirement reform and social assistance model is based on five pillars. These five pillars, adapted to South African circumstances, have been defined by the National Treasury as:
- Pillar 0. The SOAG, which provides a safety net against poverty in old age.
The SOAG is funded by taxpayers and is effectively a tool for wealth redistribution. There is general agreement that the means test must be scrapped or the threshold lifted significantly so that it does not perversely discourage people from saving for retirement.
If the threshold is raised, pensioners who are taxpayers will be taxed on the amount they receive. In other words, the richer you are, the less you will receive.
- Pillar 1. Mandatory participation, up to a threshold, in a national social security fund (NSSF) that provides basic retirement and risk benefits.
The threshold currently being mooted is 15 percent of earnings, up to R60 000 a year.
However, the National Treasury has acknowledged that people who earn less than R60 000 a year will struggle to contribute to the fund because they are already battling to afford the necessities of life.
To overcome this problem, the National Treasury has proposed a wage subsidy, on a sliding scale, to subsidise the contributions of low-income earners.
Another proposal is that the Unemployment Insurance Fund (UIF) be brought into the reform process. The idea is that when people are unemployed they first receive UIF benefits before being permitted to draw from their retirement savings.
The aim of Pillar 1 is to provide a pension that would equal 40 percent of your final pensionable income at retirement.
- Pillar 2. Additional mandatory participation in private pension funds to ensure adequate income replacement.
The additional contribution can be made to the NSSF or to another retirement fund of your choice.
However, one of the results of the reforms is that many of the approximately 13 500 existing retirement funds will disappear, while others could merge with the NSSF. This is because people who earn less than R120 000 a year (double the Pillar 1 amount) may well find it more cost-effective to belong to a single fund.
- Pillar 3. Supplementary voluntary savings, tax-incentivised up to a certain level or cap.
This is one of the catch points. The Department of Social Development suggests in its retirement reform discussion paper that mandatory contributions and the compulsory preservation of retirement savings will make tax incentives unnecessary.
Alex van den Heever, a consultant to the department, estimates it costs the state almost R24 billion a year to finance the current tax incentives.
Jonathan Dixon, the chief director of the National Treasury's Financial Sector Policy Unit, says that in reforming the retirement fund tax structures, the treasury is seeking to maintain sufficient incentives to save, while addressing the current inequities and complexities in the system.
This includes using tax incentives to encourage mandatory contributions to a basic savings component and "some tax encouragement of supplementary savings".
This means there will be a rand-amount ceiling on how much you can contribute to a retirement fund and claim as a tax deduction.
"At the moment, tax incentives are open-ended, favouring the rich. The lower-income earners below the maximum marginal tax rate receive less of an incentive, while those below the tax-paying threshold receive no tax incentive at all."
- Pillar 4. Community and state non-cash support to enhance the well-being of the elderly.
This includes things such as housing and medical assistance in retirement.
Up for debate
There are a number of important issues relating to the reform of our retirement system that still have to be resolved. These include:
- Whether to allow people to opt out of various pillars. In other words, should you be able to choose between contributing to Pillar 1 and Pillar 2 or only to Pillar 2?
The debate also extends to the issue of whether to allow a partial opt-out in terms of which you could opt out of Pillar 1's requirement to save for retirement but be obliged to use the risk cover against unemployment, death and disability provided under Pillar 1. The reason would be to improve cross-subsidisation between low-risk and high-risk members, reducing the overall costs of providing the risk benefits.
- Implementing a pay-as-you-go and/or a fully funded system for retirement funding. A full pay-as-you-go option in effect means that this generation of members pays for the pension benefits provided to those who are currently retired.
Many European retirement systems, which are based on the pay-as-you-go approach, are running into trouble because of longevity and early retirement. Fewer people are contributing to the retirement funds while more are drawing a pension.
The advantage of a fully funded system, particularly one based on members having individual retirement savings (investment) accounts, is that there will not be a shortfall of benefit payments. However, your benefits are determined by how much you save.
The advantage of pay-as-you-go is that the transition period can be shortened, with more people benefiting immediately.
Reforming the private sector
Dixon says the retirement reforms will build on the strengths of the private sector retirement-funding system.
"Ensuring a strong, cost-effective and well-regulated private pensions sector is a critical element of the overall retirement-funding strategy," he says.
Although the National Treasury is generally happy with the private sector retirement industry, it does want to see improvements in a number of areas. Many of the proposed reforms are a result of the excesses and scandals in the industry that have been exposed in recent years. They include:
- Alexander Forbes and other retirement fund administrators making "secret profits" at the expense of retirement fund members;
- The life assurance industry levying confiscatory penalties on RA fund members who can no longer afford to maintain their contributions; and
- Fidentia's plunder of the retirement fund death benefits owed to 46 000 widows and orphans, mainly beneficiaries of the Mineworkers' Provident Fund.
The aims of the reforms include:
- Lowering the cost of saving for retirement. The National Treasury says it wants to tackle this by:
* Reducing the large number of funds currently in existence to encourage economies of scale;
* Enforcing the full disclosure of fees; and
* Stimulating competition by allowing fund members to transfer freely between retirement products offered by the entire financial services industry.
- Protecting members' benefits. The measures the National Treasury is contemplating include:
* Ensuring fund members receive a minimum benefit at retirement.
* Making it compulsory for members to preserve their retirement savings, but integrating this requirement with improved social security benefits, such as the UIF benefits.
* Ensuring members receive an adequate pension that lasts until death. This means provident funds that allow you to take all your retirement savings as a lump sum at retirement will be phased out.
* Improving oversight of beneficiary payments.
- Tightening up regulation so that fund members are better protected. The proposals include:
* Setting higher standards for the accreditation of retirement funds;
* Enhancing fund governance through measures such as implementing strict codes of conduct for fund trustees and service providers; and
* Raising reporting standards.
- Simplifying how retirement savings are taxed. From October 1 this year, the complex formulae that were used to determine the tax on lump sums withdrawn from retirement savings have been simplified. Now, you will be permitted to withdraw the first R300 000 tax-free, the second R300 000 will be taxed at 18 percent and the third R300 000 at 27 percent. Any further amount you withdraw will be taxed at 36 percent.
If you are a member of a pension fund or an RA fund, you must use two-thirds of your tax-incentivised retirement savings to purchase a pension.
Dixon says the aim is to have what is called an "EET" retirement fund tax model. The initialism stands for exempt, exempt, taxed. This means that your retirement fund contributions (up to pre-determined levels) will be tax-deductible; there will be no tax on any investment growth (retirement fund tax on investment growth, which was implemented six years ago, was dropped this year); and your pension is fully taxed at your marginal income tax rate.
Joint effort
The reform process, which includes the complete redrafting of the Pension Funds Act, is being driven by an inter-ministerial committee chaired by Manuel and managed by a government inter-departmental task team, chaired by the National Treasury.
There are a number of sub-task teams on design options, administrative and infrastructure reforms, fiscal modelling, social health insurance and the low-income wage subsidy.
The reforms will also be negotiated between business, organised labour and the government at the National Economic Development and Labour Council (more commonly known as Nedlac).
The reform process is not expected to be completed before 2010, although in the interim some piecemeal legislation could be enacted to better protect fund members.
This article was first published in Personal Finance magazine, 4th Quarter 2007. See what's in our latest issue