The ongoing fracas around the retirement annuity (RA) business will no doubt have a deeply negative impact on our savings rate. Currently, South Africa’s savings rate is among the lowest in the world at just under 15% of gross domestic product (GDP), a fraction of the 36% savings rate of South-East Asia. According to the International Monetary Fund (IMF), a developing country needs a savings rate of 20% of GDP to sustain a growth rate of 3% per annum.
When one drills down, the reality is that households only save around 3% of their income; companies and the government are the greater savers. The social impact of this is enormous. More and more people are retiring without sufficient income to live on, so it is not surprising that Minister of Finance Trevor Manuel is taking such an active interest in the retirement industry.
An RA, unlike other investments, is specifically aimed at providing a retirement income. You also receive a tax break when investing in an RA. (You can cash in your policy before retirement, but there is a tax disincentive.) Upon retirement, you are compelled to invest two-thirds of your proceeds into a life or living annuity to provide a retirement income.
This sort of incentivised saving is necessary in a country that loves to spend. It encourages people to invest in a vehicle whose sole purpose is to provide an income at retirement. What the recent dispute has done is provide people with another reason to blow their cash on a holiday rather than invest in what they perceive to be a black hole of commissions and fees.
According to a recent press release Adrian Gore, CEO of Discovery, describes RAs as ”expensive to invest in; they create investment risk for the policyholder at the time of retirement; surrender values are low; expectations at retirement are not being met; and income during retirement is inflexible”.
Yet these are the very products created for retirement savings, especially for people who fall outside the formal employment net.
It is for this reason that it is imperative that reforms in the retirement industry take place. If companies bring products to the market that are fee-friendly and the recent recom-mendations by the Life Offices Association to reduce upfront commissions are implemented, consumers need to know about it. Consumers need somewhere to invest for their old age, somewhere that is not temptingly available when they need extra cash.
Discovery Life came to market this week with an innovative RA product that protects the value of the investment should it be made paid up or have its premiums reduced. This highlights the fact that innovation is possible and that consumers are becoming more financially educated and certainly more vocal, which will result in increased innovation and cost-cutting.
But the buck does not stop at life companies. Manuel, while being vocal on the cost structures of retirement products, also needs to turn the eye inward and consider the tax incentives of investing for retirement. Commentators have argued that the tax incentives on retirement products have not kept up with inflation and increased salaries; and then there is the taxation of interest income within retirement funds.
The minister has made it clear that he wishes retirement vehicles to become accessible to the lower income earner who would put the most pressure on the social security net. However, many who are below the minimum tax threshold would effectively be penalised by the 18% tax rate on interest income. The same would apply to people who have retired and converted their RAs and pensions into compulsory life annuities. They could be better off investing outside a retirement vehicle and making use of their tax-free interest-income provision, which was increased in the most recent Budget speech.
Between life companies and the government, the issue of retirement funding needs to be addressed — because the social security net is not going to hold.