Members of small company retirement funds could be paying as much as 8% for their retirement fund each month.
Because of the high cost structures of umbrella funds, it may not make economic sense to offer employees a retirement fund and financial officers of small companies need to interrogate the fees they are actually paying.
The reason these fees are not widely understood is that they are represented as a percentage of salary not as a percentage of contributions.
The following is an example taken from a school which belongs to the umbrella fund of one of the large life companies:
- Provident Fund contribution — 10% of salary
- Approved risk benefits — 0,92% of salary
- Management fee — 0,78% of salary
When the financial officer of the company sees fees of 0,78% of salary, it sounds reasonable.
They know that a retirement annuity would have fees of about 3% to 5%, so by offering their employees a company retirement fund they are offering a perk — because it is so much cheaper.
However they are confusing percentage of salary with percentage of contribution.
Once you do the calculation based on contributions, the costs are horrendous. For example a member of this fund, earning a R15 000 a month, would contribute R1 500 a month to the fund.
The monthly management fee of 0,78% would be R117 — this works out at 8% of the R1 500 monthly contribution. This is before investment management fees on the underlying assets which in the case of umbrella funds can be as high as 1% per year.
Little wonder that South Africans are not saving enough for their retirement. Who is to blame and what are we going to do about it?
A recent independent study commissioned by the retirement industry and conducted by Compass Management Consulting, found that umbrella fund pension/provident funds used by smaller companies are expensive. The problem however is that there is no reasonable alternative as a standalone fund is not cost effective for a company with fewer than 50 employees.
According to Anton Davies, the actuary behind the study, the South African umbrella business is made up of many small unrelated schemes, often with their own sets of rules which increases costs.
In addition, for many umbrella funds, investment in IT infrastructure in anticipation of an increase in membership numbers has not yet paid off as numbers remain low so fixed costs remain high.
Assets under management are also lower, with the average member’s assets worth R61 000 compared to R210 000 for larger standalone schemes. Therefore asset management fees as a percentage of assets is higher for umbrella funds.
What Davies found is that on average the fixed cost per member per month for an umbrella fund is around R116 (including investment fees).
This is what it costs to run a fund and does not include profits.
So for a company that has lower paid workers, the cost as a percentage of both salary and as a percentage of contribution will be higher. Costs as a percentage of contribution are also affected by the level of contribution.
For example if this teacher contributed 15% of his/her salary to the provident fund then the costs would be R117 of R2 250 or 5% of contributions. Lower, but still very high.
There needs to be a radical re-think around our retirement structures, clearly what is on offer at the moment is unacceptable. Davies believes that these costs could be driven down significantly for both standalone pension funds and umbrella funds.
Firstly retirement funding needs to be made compulsory as this would remove the need for companies to employ brokers and would remove commissions. It would also improve economies of scale and reduce per member costs.
Secondly tracker funds could be used rather than actively managed funds. This could for example cut investment costs to about 0,1% (currently between 0,47% and 1%). Davies says this would save the average member of a standalone fund about R80 a month and an umbrella fund about R20 a month.
Finally there needs to be legislative and operational changes that makes it less expensive to administer a retirement fund. For example two of the biggest costs incurred by company retirement funds are contribution reconciliations, (here they need to confirm each month that the contribution received is the correct percentage of salary) as well as investigation on death of who the dependants are.
Small companies at this stage need to decide whether it is optimal to offer a retirement fund or possibly contribute to employees retirement annuities. Companies can now receive tax benefits for RA contributions. One would need to do a cost analysis by comparing the reduction in yield on the investment. For example the upfront fee may be lower on an RA but the annual investment fees are higher. If employees opt for a unit trust RA directly through companies like Allan Gray, Coronation or Investec, it could be significantly cheaper than offering a company fund.
The GAP FundThe retirement industry has proposed a GAP fund for lower income earners who do not benefit from the tax incentives of retirement savings as they earn too little to pay tax.
The fund would be compulsory but would have contributions from the employee and employer as well as from government to incentive people to save. This is very much along the line of the Fundisa education savings fund.
Rowan Burger of Liberty says that in order to be fair to lower income earners, the government needs to provide them with a similar financial incentive to save for retirement. Currently that would work out at about 10% of contributions but this could be even higher.
The proposed Gap fund would be a low-cost, unitised investment savings account administered in the name of the member and would cater for regular and ad hoc contributions. It would allow some limited access to savings regardless of age as well as a death benefit.
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