The treasury’s discussion document issued this week, “Strengthening Retirement Savings”, demonstrates that it has a good grasp of the issues in the retirement industry. But the challenge will be in finding solutions that are not watered down to please major interest groups and that require out-of-the-box thinking.
The compulsory preservation of retirement funds will certainly draw criticism from trade unions and there is concern that it may discourage people from saving into a retirement fund if they feel they will lose access to their retirement money.
However, the government has to find a solution to the fact that, despite having one of the highest coverages in the world in terms of pension fund membership and contribution levels, only 10% of South Africans retire with sufficient funds because of a lack of preservation when changing jobs.
The drive by the Financial Services Board to separate product fees from advice fees will be fiercely opposed by the insurance industry on behalf of its sales force. Its argument is that the South African market is not yet ready for a fee-based model and in many ways it may be correct. But the current model does create perverse incentives, drives up costs and is not always in the best interests of consumers.
It is the complication in the design of products that obscures exactly which services the consumer is paying for and the treasury wants them to understand fully which fees are going to whom in the pecking order.
“Many retirement products have multiple layers of charges, such as administration and investment management charges and brokerage, adviser and performance fees, making comparisons across products and channels difficult. The costs of investment management in particular are high,” said the treasury.
It would like to see a simplification of products in which providers compete on price rather than design, which tends to complicate products and reduces the level of transparency for consumers.
David McCarthy, retirement policy specialist at the treasury, said the complexity in terms of pricing and rebates might also be why passive investments remained underutilised in South Africa because no retirement platform provided these cost-effective products.
What is also clear from the paper is that the treasury acknowledges the costs of regulation, in particular the Financial Advisory and Intermediary Services Act. Realistically, the amount of time an adviser needs to spend with a client to sign a R200 debit order for a unit trust cannot be covered by the fees, which is why advisers are driven to selling higher-fee products. It may also be why passive investment funds continue to be underutilised in the retail space.
The treasury will be investigating the exclusion of certain products from the Act. “We want to have standardised products that can be bought without advice and without costs,” said Ismail Momoniat, deputy director general for tax and financial sector policy at the treasury. These products may underpin the treasury’s plan to introduce tax-free savings plans.
In recognition that compulsory preservation will limit people’s access to emergency funding, there are proposals to introduce a tax-free, short-to-medium term savings product. Individuals will be able to save up to R30000 a year tax-free, with a lifetime limit of R500 000. This could have a major impact on the retirement annuity industry because clients may replace their retirement annuity “top-up” with the new plan.
It is also proposed that this new savings plan will replace the existing tax-free thresholds on interest income, so savers will have to save in designated products to receive this exemption.
Although the standardisation and simplification of products is a step in the right direction, the treasury may be overestimating how many people save without interaction with an adviser. The take-up of two savings products initiated by the government, the RSA Retail Savings Bond and education savings fund Fundisa, have been much lower than expected, suggesting that products are still sold rather than bought. Time will tell whether the tax incentive will be enough to change this behaviour.
The paper also raises discussion points about post-retirement and the role of living annuities. McCarthy said the majority of retirees purchased living annuities, but the experience was that incorrect investment decisions were often made and the draw-downs were too high.
“We are very concerned about the ability of most people to successfully manage products of that complexity,” said McCarthy.
The treasury is considering developing a living annuity with an underlying investment in South African retail bonds to provide an additional simple, low-cost product to meet retirement income needs. The paper also takes aim at the cost of living annuities that “are too high”.
Umbrella funds and group retirement annuities favoured by small companies came up for a special mention. The paper talks about “mandating charging structures to prevent price discrimination against small firms or employers with lower-paid workers”, but McCarthy said it was not a simple solution: small funds were more costly to run and one did not want a situation in which service providers no longer offered umbrella funds because the mandated fees did not make it cost-effective.
A Band-Aid on a broken arm
The “Strengthening Retirement Savings” document is well conceived and deals in detail with many of the issues facing the retirement industry. But the concern is that we are spending an inordinate amount of time and energy on a topic that is relevant to only a small percentage of South Africans.
The average life span in South Africa is 54 years. Most South Africans will not reach retirement age and they have far more pressing issues to consider, such as survival, disability and illness.
But in terms of compulsory preservation, the question the treasury should be asking is: Why do 90% of South Africans withdraw their pensions?
During the 2008 financial crisis, the industry saw an unprecedent-ed number of people resigning from their jobs to access their pension funds. There were reports of couples getting divorced for the same reason.
We know that nearly half of credit-active South Africans – and these would be the same people who have jobs and are members of pension funds – are indebted and struggling to meet their financial requirements.
What is needed is a far broader discussion on the state of household finances and our general levels of financial literacy. We need to discuss the roles of the employer and service providers in educating people and providing advice. We need to discuss the role of education and how to deliver basic financial literacy messages from an early age. We need to talk about the role of credit providers in providing counselling to overindebted customers.
We need to start finding ways to improve the financial management of households so that we deal with the root causes rather than introducing legislation to treat the symptoms. – Maya Fisher-French