Time is eroding nest eggs
Today’s average 40-year-old is likely to have 30% less funds in retirement than the previous generation because of lower market returns, longevity and a lower savings rate relative to income, a recent study by Alexander Forbes suggests.
The Alexander Forbes Pensions Index, launched in April, indicates how the income a typical person is projected to receive in retirement has changed since January 2002. The index tracks three indices based on three savers and reflects the impact of market conditions, longevity and savings rates across generations. The three savers were born on January 1 1972, 1962 and 1952, respectively.
On January 1 2002, they were 30, 40 and 50 years old and all expected to be on track to have a pension that replaced 75% of their pre-tax salaries when they retired at age 65. This means that their index value was 75 on January 1 2002.
However, because of declining market conditions, by 2012 these values had fallen significantly and the 60-year-old born in 1952 is now expected to receive an income of only 57% of final salary in retirement, whereas the 40-year-old saver is expected to receive a replacement value of only 40%.
Michael Prinsloo, head of best practice at Alexander Forbes’s research and product development department, said all three savers were invested in the same way. However, the saver born in 1952 had a considerably better index value than the saver born in 1972 because the retirement-savings landscape had changed.
Prinsloo said the investment outlook today was considerably gloomier than it was 10 years ago and younger members were expected to be invested in these less favourable markets for longer. In addition, salary inflation has been high relative to investment returns in recent years. It decreases the index because past savings are proportionately lower relative to the current salary and this effect is amplified over time to retirement when final salaries are expected to be considerably higher for younger members.
For the members who are only five years away from retirement, an effective drop in expected retirement income of 24% over the past 10 years has serious consequences.
They have only five years in which to boost their reduced savings. Alternatively, they will either have to work longer, where possible, or seriously scale down their lifestyle in retirement.
Alexander Forbes said, although younger members did have time to rectify problems, the index showed they were sensitive to weaker market conditions and also faced two additional challenges: longevity and higher consumption rates.
In terms of longevity, the costs of purchasing an annuity on retirement are expected to increase as insurers price for the average member to live longer. At the same time, younger people have much higher rates of consumption than the previous generation, which not only leaves less money to save, but also increases the cost of their lifestyle on retirement.
Ultimately, younger people will need to increase the amount they put away for retirement. It is unlikely that a 40-year-old today will be able to afford to retire at age 65, especially if they are expected to live into their 90s. Prinsloo said this would also require a rethink by employers about employees’ contribution rates and retirement ages.
The cheapest way to save for retirement
In a low-return environment, costs will have a greater impact on the amount of funds available in retirement. In its recent discussion document on retirement reform, “Strengthening Retirement Savings”, the treasury indicated that it would like to have retirement products with costs of less than 1% a year. There are no actively managed retirement annuities in the market that can meet this target. In fact, most cost about 2% to 3% a year. However, there are index-tracker retirement annuities that meet these requirements, as long as there are no additional adviser fees.
10X Investments has a balanced tracker portfolio that can be used for a retirement annuity or preservation fund. The portfolios are based on age and years to retirement. A 10X retirement annuity will cost you less than 1% a year and there are no adviser fees.
Old Mutual Unit Trusts offers two low-cost, long-term investment portfolios that fall in the 1% cost structure targeted by the treasury. The Old Mutual Rafi 40 Fund is an enhanced index-tracking fund that takes into account a number of fundamental investment principles (cash flow, sales, dividends and book value) in constructing a portfolio of 40 stocks. The fund’s annual service fee is 0.86% and the total expense ratio is 0.88%.
Investors can also consider a more traditional approach and invest in the Old Mutual Top 40 Fund, giving them exposure to the largest 40 companies on the JSE. The fund’s annual fee is 0.68% and the total expense ratio 0.73%.
To adhere to regulation 28 requirements for retirement investments, investors can include 25% money market in the portfolio, further reducing the total cost. By combining 75% Old Mutual Top 40 and 25% Old Mutual Money Market, the investor can reduce the total cost to 0.65%.
These funds can be used in Old Mutual Unit Trusts retirement-product wrappers, including the retirement annuity, preservation fund and living annuity. There is no product cost associated with investing in retirement products. – Maya Fischer-French