Planning your retirement is your responsibility, writes Michael Metelits
The dream of retirement is to spend your golden years savouring life and doing things you never had time to enjoy when working – the soft-focus approach favoured by advertising agencies.
But a prerequisite is enough money, otherwise you can fall into a grim and grey old age spent trying to survive on a minute pension or the King Lear approach of relying on your children (and we all know what happened to him).
So retirement planning should come to us all. Unfortunately the retirement industry often appears to be a bewildering maze of options and products, all with strong and weak points. The idea is to pay now and play golf later on the accumulated premiums and added value that the retirement fund manager has piled in using his or her considerable investment expertise.
It sounds nice, and when it works out it is, but it doesn’t always have a happy ending. And since it will be you, rather than your fund manager, living on cat food if things don’t go well, you need to understand what is going on. What are the different products and what kinds of economic conditions enable them to work?
South Africa has three main types of retirement schemes: pension funds, provident funds and retirement annuities. Pension and provident funds come in two different flavours: defined benefit or defined contribution. The different varieties of funds carry distinct levels of security and have different methods of operating. But they are all designed to provide a pool of investments which will either directly supply income at retirement or enable the employee to buy a plan that will provide that income.
Defined benefit plans provide a secure level of income. They work on a fixed formula and pay out a set amount on retirement. The amount of a defined benefit pension is arrived at by multiplying the number of years of service with a pension rate, often 2%, and the amount of the employee’s salary at retirement. So if you worked for 30 years, earned R200 000 a year at retirement and your fund provided a pension rate of 2%, a defined benefit plan would provide 60%(30 x 2%) of R200 000, or R120 000 per year.
Defined contribution funds operate more like savings accounts. The employee and employer both put in a proportion of the former’s salary, which over the years will produce a lump sum at retirement. The employee can then buy an income providing plan which they can use to fund the improvement of their golf game.
Retirement annuities work like defined contribution funds, except that the assets are under the employee’s control, rather than being vested in a collective fund. Again both employer and employee contribute, but the latter manages the pool of funds according to his or her appetite for risk, skill and ability to find good advice. Retirement annuities can also be bought solely by individuals.
All these funds are regulated by the Pension Fund Act. This specifies a maximum of 75% investment in equities and the balance in safer bonds or cash, in order to limit the risks involved in such funds. However, no investment is totally without risk, and the turmoil in financial markets in recent months raises questions about how badly the different plans can be affected – an issue especially important to people nearing retirement.
Defined benefit plans are relatively safe, since benefits are specified and if the fund runs short of money due to investment losses, the employer must make up the difference. However, if losses get too far out of hand, defined benefit pension liabilities could bankrupt the company.
Given recent recovery of the markets of almost half of their August losses, Niel Krige, chair of Momentum Employee Benefits, thinks it unlikely that these funds will find themselves in default.
Members of defined contribution funds and retirement annuities face greater uncertainty as their retirement income is more directly linked to investment income and value, so when markets head south, members must wonder if they will be able to retire comfortably.
Krige says there is concern that defined contribution members may not be aware they are carrying the full investment risk.
Because their post-employment golf game depends on the value of the fund’s investments at retirement, members of defined contribution funds may have to postpone retirement or continue to find ways to get paid if things work out badly for the fund. “It is important that members [of defined contribution funds] monitor their situation and make provision for adequate income at retirement,” he says.
Since investment risk is carried by members, defined contribution funds are protected in the long term against bankrupcy. Alan McCulloch of Liberty Life’s Millennium Group is upbeat about defined contribution funds. “Short-term market moves don’t affect the long-term viability of these funds”, he says, stressing that retirement investment is about as long-term as investment gets.
With a sound investment strategy, he says, “it is inevitable that markets will recover and surge ahead in the years to come”.