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The eight-factor retirement outcomes lesson

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08 November 2021 Gareth Stokes

There are eight factors that influence outcomes in South Africa’s retirement funding landscape, and financial planners need to be aware of each one as they guide clients towards a successful retirement. The 2021 Member Insights ™, now in its 16th edition, offers a unique assessment of the behaviours and experience of a million pension fund members. “Each of these eight factors affect the end result,” said John Anderson, Executive: Investments, Products & Enablement at Alexander Forbes, during a media launch of the report. “The industry has tried to help members [to address these factors] through the introduction of defaults, improved communication and better legislation; but much more still needs to be done to improve the ultimate outcomes”.

A multi-year experiential analysis

Member Insights is a multi-year experiential analysis of South Africa’s ongoing migration toward a defined contribution (DC) retirement funding environment. The report gives valuable insight into the impact of both industry and regulatory interventions on retirement savings outcomes in the context of members’ actual behaviours. In 2021, it ‘crunched’ the age, gender, retirement saving and salary data of over a million savers for the period 1 January to 31 December 2020. And, for the first time ever, the report also referenced a raft of non-pension data. “We have enriched our data with further insights; for this year we have included measures such as indebtedness and a range of demographic and geographic information [gathered from non-pension data sets],” said Anderson. More on these finding later; first we touch on the eight factors affecting retirement outcomes. 

The first factor impacting retirement savings outcomes is how much pension each rand of savings can purchase at the time of retirement. This rand value varies from time to time based on prevailing real interest rates and inflation and return expectations. Anderson noted out that the economic conditions entering into pandemic were “favourable” for retirees to secure better life annuity rates, which translated to a slight improvement in the net replacement ratio (NRR) recorded for 2020. Unfortunately, this NRR remains poor, at just 31.47%, compared to the 75% being targeted as optimal. Only about 6% of retirees in the analysis achieve the higher level. According to Anderson, the shortfall is due to decades worth of low contributions, failures to preserve and contributions not keeping up with inflation. 

The expense and group risk ‘drag’

The second factor is described as “the expenses that are deducted for risk benefits and admin costs”. Employee benefits contributions are typically separated into an administration cost, group risk premium and retirement funding portion, and any increases in non-retirement deductions can have significant impacts on the final capital value at retirement. “There is a constant balancing between expenses and risk benefits versus retirement,” said Anderson. “Group risk benefits are extremely important because without them many people will be without death, disability and funeral cover … this protection proved critical during pandemic and will remain so with the potential impact of long-Covid”. 

Investment returns after fees and the portfolios that members are invested in was singled out as the third factor influencing your client’s retirement saving experience. Although this factor was not unpacked during the media presentation, there have been concerns over the 10-year returns generated from various domestic equity classes, especially given the impact of Regulation 28 on portfolio construction.  The fourth factor relates to how a member’s salary has progressed. “We tend to think that great salary growth means a great replacement ratio, it does not; the replacement ratio depends on the growth of the salary and the underlying investments, how much you have saved and how much of your salary increase you contribute towards retirement, to maintain your new lifestyle, essentially on a higher salary base,” said Anderson. 

Preservation and the two-bucket debate

The fifth and sixth factors are somewhat interlinked and relate to preservation. These consider how much is lost to non-preservation along the member’s retirement savings journey and balancing short-term financial needs and long-term savings goals. One of the arguments is that retirement savers choose to withdraw their accumulated capital when changing jobs to meet other financial commitments. In fact, there is plenty of evidence that employees will resign for the sole purpose of getting their hands on their accumulated savings. The good news is that National Treasury’s latest proposal to address this problem seems promising! 

The proposal would split new retirement fund contributions into two buckets, one which would have to be preserved until retirement and the other which could be accessed for financial emergencies, subject to strict conditions. “We have done some modelling [using a 70:30 split] that suggests a significant improvement in outcomes, being anywhere from a two to two-and-a-half times gain in accumulated savings over a 35 to 40 year period,” said Anderson. This exercise was also carried out by the Actuarial Society of South Africa (ASSA), with similar results. 

The seventh factor centres on how much of your client’s retirement savings are used to generate an income in retirement versus the flexible application of such capital to leave a legacy. Financial advisers and planners are quite familiar with this step, which usually involves advising their clients on purchasing a life annuity or investing in a living annuity structure. More recently, the focus has shifted to some form of hybrid arrangement in which retirement capital is optimally divided between life and living annuity structures over time. Finally, the eighth factor deals with the cost of converting savings to a pension at retirement. 

A snap-shot of members’ credit behaviour

Much of the media presentation focused on insights gained from an analysis of non-pension data. Alexander Forbes said that the average age of retirement across the million odd retirement savers in the Member Insights report was 40-years, and that the average household income was just R28 653 per month. Anderson said they were able to match 87% of members to credit records, which put a fresh ‘spin’ on the 2021 report. Based on this data, we now know that 95% of members are credit active; 33% have a credit card; 24% have a mortgage; and 23% vehicle loans. And the total debt to annual income ratio across the sub-set of credit records was around 69%. 

Although the overall average credit rating of members is not bad, there are signs that Covid-19 has had a negative impact. Anderson pointed out that both the proportion of loans going into default and debt to income ratio were increasing and likely to get worse in 2021. And it is feared that these increased levels of financial stress will have a knock-on, negative impact on retirement outcomes. Anderson concluded by saying that retirement funds needed to do more to improve retirement savings outcomes by encouraging preservation and assisting members to make better decisions at each retirement savings inflection point. The Member Insights report proves invaluable in shining the spotlight on those funds that are making progress in this regard. 

Writer’s thoughts:
I was surprised by the ASSA and Alexander Forbes findings re the impact of National Treasury’s proposed two-buckets system on retirement savings outcomes; but after giving it some thought, the result is fairly intuitive. It makes sense that savings will improve if savers are prevented from getting their hands on all of their accumulated savings by simply resigning from a fund. Have you ever debated the ‘preserve or not’ issue with one of your clients? How do they typically respond to the preservation alternative? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected]