/ 29 July 2011

Retirement is the test of saving

Retirement Is The Test Of Saving

The majority of South African consumers have inadequate long-term savings strategies in place. Reasons for poor long-term saving include unemployment and poverty, low life expectancy, poor financial literacy and a penchant for consumption expenditure.

The country’s poor retirement savings performance is of major concern to government and the financial services industry. Experts say that as few as one in 10 people are making adequate provision for retirement.

But Pieter Koekemoer, head of personal investments at Coronation Fund Managers, says it is difficult to accurately measure the problem. A research study conducted by Alexander Forbes concluded that only 12% of approximately 700 000 retirement fund members would retire “reasonably” financially secure.

“The Alexander Forbes’ Member Watch series showed that the average outcome achieved by individuals retiring from funds was a net replacement ratio (the ratio of pension income to final salary) of around 30%,” says Michael Prinsloo, head of employee benefit consulting strategy at Alexander Forbes.

And only one in 10 retirees in the survey achieved a replacement ratio better than 75%, the number touted by the industry as ‘acceptable’. Of greater concern is the number of South Africans not covered by any private retirement savings.

“There is a significant coverage gap because around a quarter of the formally employed and most of the informally employed do not belong to a formal retirement plan,” says Koekemoer. And the problem compounds further when we consider that two thirds of the eight million individuals with formal employer-sponsored or personal plans are probably under-providing.

It is human nature to focus on the now — surviving from month to month — rather than obsessing over an event three or four decades hence. “That’s why the majority of households do not have an emergency lump sum saved, while providing for retirement is often not even on the agenda,” says Peter Doyle, president of the Actuarial Society of South Africa.

“Given the strong emphasis during July National Savings month on helping South Africans improve their savings efforts, it is important that we provide consumers with an indication of what their long-term savings goals should be,” he says.

How much do you need to secure a comfortable retirement?

“The difficulty is deciding what ‘comfortable’ means, and to accurately measure the retirement experiences of a representative sample,” says Andrew Davison, head of institutional asset consulting at acsis. Some people might be ‘comfortable’ in the early years of retirement only because they draw down against their saved capital.

They will struggle to increase this ‘salary’ in line with inflation, with the result that their ‘comfort’ levels will decline during retirement. The capital lump sum required varies from person to person based on their age at retirement, their post-retirement income expectation and the way in which their retirement solution is structured.

“The rule of thumb for retiring independently is that you will need a capital sum of 15 to 20 times your final annual pre-tax income,” says Jeanette Marais, director of distribution and client services at Allan Gray. This capital amount should be sufficient to secure a net replacement ratio of 70% at age 65.”

Doyle agrees, saying that someone retiring at age 60 will have to save R6-million for each R15 000 per month in income required, assuming they don’t want to ‘burn through’ their accumulated capital. Fortunately the typical retirement solution allows for some draw down against the capital value, so a reasonable income could be ‘bought’ with lesser sums.

“For South Africans living on the breadline, saving money is an unattainable luxury,” says Doyle, before adding that this social grouping would probably survive on government grants through retirement.”

The State Old Age Grant scheme (at 1 March 2011) pays qualifying South African citizens permanently resident in the country an amount of just R1 140 per month. You can apply for the grant from age 60, provided your existing income from sources such as pensions or other assets does not exceed a minimum amount.

This “means” test, which is adjusted from time to time to keep pace with inflation, has been criticised as a disincentive to saving among poor income groups. And employed individuals will find it virtually impossible to maintain their current living standards with such a small amount.

It is therefore clear that each and every employed individual should adopt saving for retirement as their number one financial planning priority. New cars, bigger houses and wardrobes filled with the latest fashions won’t compensate for poor long-term saving.

The current retirement savings environment is dominated by private sector pension funds. But there are moves afoot to implement retirement reforms in South Africa. Some time ago, National Treasury published a white paper proposing that all employed citizens make mandatory retirement funding contributions to a state-controlled National Social Security Fund (NSSF).

Unfortunately the global financial crisis put paid to a quick-fire implementation and, three years after the initial proposal, Government and private sector stakeholders have yet to thrash out the details of the plan.

Can we rely on a state retirement solution — assuming it is implemented — to fund our current lifestyles through employment?

Based on experience from the private sector the answer to this question must be no. Davison explains: “Regardless of your pension fund, it is not wise to rely solely on this fund to provide for your retirement. You need to make additional provision in unrelated vehicles to diversify your risk.”

If you cannot rely entirely on your privately-managed pension fund, then relying entirely on a government fund making lower provisions will be financial suicide. Savers can use a number of investment products to put away additional retirement savings.

“One of the key challenges when saving for retirement is to resist the temptation to access the money,” says Davison. “For this reason, retirement annuities and preservation funds are good, retirement-dedicated investments.”

Other possibilities include unit trusts, provided you can avoid accessing them for other purposes. Depending on a person’s income level and the final contribution rates set out for the NSSF, a retirement payout is unlikely to be sufficient for most currently employed people, especially those earning more than R75 000 a year,” adds Koekemoer.

Government will also face the near impossible task of making the system fully funded. “Most of the developed world have made unsustainable promises to their citizens and are faced with having to roll back entitlements significantly,” concludes Koekemoer. “Any new system in South Africa will only be sustainable if it is properly funded and affordable.”

The best retirement funding solution would be to plug the gaps in the current system rather than building a new compulsory contribution system from scratch. Perhaps a decade from now we will have an independently-governed default scheme with automatic enrolment for all new employees, similar to the UK National Employment Savings Trust.

Until such solutions are implemented here — and probably for decades after — your retirement well-being is entirely in your own hands. After analysing responses from the 2010 Sanlam Benchmark Survey, Danie van Zyl, head of guaranteed investments at Sanlam Employee Benefits, suggests the following steps to ensure you accumulate enough capital for a comfortable retirement.

The most important is to start planning for your retirement at the earliest possible stage. “Often members only start planning their retirement five years before their retirement date,” says Van Zyl. But it makes sense to ramp up your planning regime at least 20 years prior to the big day.

A second important step is to begin putting away money as soon as you receive your first pay cheque. Each amount saved can then benefit from compound interest (the interest earned on interest over time). And finally — no matter what your personal circumstances — do not withdraw money from your retirement savings prior to retirement.

It is important to resist the temptation to spend your accumulated retirement capital when you change jobs. The accepted path to the Holy Grail of retirement savings goal is to put away 15% of your gross income over your entire working lifetime (at least 35 years) — and to always preserve, concludes Marais.

If you follow this recipe then you should be able to enjoy an inflation-adjusted salary in retirement at least equivalent to three quarters of your final gross salary pre-retirement.