A shocking 81 percent of retirement fund members will retire with a pension that will in no way be sufficient for them to sustain their pre-retirement lifestyle. In fact, most fund members face penury.
Currently, only about 12 percent of retirement fund members enter retirement reasonably financially secure. The overall number is even lower once account is taken of people, both employed and never employed, who contribute nothing to a retirement-funding vehicle.
These are the shock results of the latest research by retirement fund services provider Alexander Forbes. They mean that most people face:
* Slashing their standard of living at some point in retirement; and/or
* Staying employed, either in their current job or they face the difficult prospect of finding a post-retirement job.
The Alexander Forbes research is based on about 700 000 retirement fund members on its database.
The research excludes the millions of people who are not members of retirement funds and will have to rely on the state’s old-age grant of R1 080 a month to sustain them after the age of 60.
John Anderson, the head of institutional strategy at Alexander Forbes, says the sad part of the research is that it shows that most retirement fund members start off well when they begin working, but, as they get older, they increasingly fall off the secure retirement bus.
A major reason for the crisis is that fund members do not preserve their accumulated retirement savings when they change jobs.
Other reasons include low contribution rates, inappropriate investment portfolios, the inappropriate switching of investments, poorly performing investments, high costs, and the significant difference between actual total income and deemed pensionable salary. (Only part of your total income is used to calculate the contributions to your retirement fund. In most cases, things such as a travel allowance and an annual bonus are not taken into consideration.)
Anderson says the crisis is compounded at and into retirement. For example, pensioners often withdraw large lump sums at retirement and use them for non-pension-funding purposes; pensioners often withdraw excessive amounts as a monthly pension in their initial years of retirement, resulting in a shortfall later; often, insufficient consideration is given to the effects of inflation in retirement; and in some cases insufficient allowance is made for a spouse’s pension. All these factors contribute to a large portion of pensioners or their spouses not having a sustainable pension for life. In many cases, they only realise this many years into retirement, when the problem is very difficult to rectify.
The Alexander Forbes research is based on what is called the net replacement ratio (NRR). An NRR is the percentage of your final pensionable salary (your basic salary without perks such as a travel allowance or an annual bonus) that you will receive as a pension.
Most retirement funds aim at providing you with an NRR of between 75 and 80 percent after 35 to 40 years of fund membership.
An NRR of 75 percent assumes that you will have little or no debt when you retire and that you will incur lower living expenses in retirement than you did while you were employed, Anderson says.
An NRR of 60 percent is generally considered the absolute minimum; below it you are not going to come anywhere close to maintaining your pre-retirement lifestyle.
And if you take one-third of your retirement savings in cash to spend on things such as paying off debt or going on a round-the-world cruise, you will further reduce your NRR and your ability to avoid penury at some point in retirement.
The Alexander Forbes research shows that after 40 years of potential fund membership:
* 12 percent of fund members reach retirement with an NRR of more than 75 percent;
* Seven percent of fund members have an NRR of between 60 and 75 percent;
* 10 percent of fund members have an NRR of between 45 and 60 percent;
* 14 percent have an NRR of between 30 and 45 percent; and
* 57 percent of retirement fund members have an NRR of less than 30 percent of their final pay cheque.
A FATAL MISTAKE YOU CANNOT AFFORD TO MAKE
If you change jobs and cash in your retirement savings, you will dramatically reduce your chances of retiring financially secure, and you stand to lose money to tax.
The sensible options you should consider when you change jobs are:
* Leave your retirement savings in your current occupational retirement fund, if the rules of the fund allow you to do this. You become a deferred pensioner, and your savings continue to accrue investment returns until you retire. There will be no costs or tax implications.
* Transfer your retirement savings to another occupational fund, if your new employer offers one. There will be no costs or tax implications.
* Transfer your savings to a preservation fund or a retirement annuity fund. You will incur costs, which will vary between products. You may also have to pay commission to a financial adviser. There will be no tax implications.
‘MORE HANDS-ON APPROACH NEEDED’ TO IMPROVE YOUR RETIREMENT PROSPECTS
Members of defined contribution retirement funds need better information than an annual benefit statement that tells them the current value of their accumulated savings: fund members need to know whether or not they are on course to retiring financially secure.
John Anderson, the head of institutional strategy at retirement fund services provider Alexander Forbes, says that both retirement fund trustees and employers need to take far more responsibility for educating fund members about how they can retire financially secure.
In addition, legislation and regulations should be updated to incorporate ways to improve financial outcomes at retirement, he says.
The purpose of a retirement fund is to provide an outcome that will provide members with a financially secure retirement, but not enough is done to ensure that employees achieve this, Anderson says.
In many cases, he says, the approaches used to manage a defined contribution fund are similar to those adopted by a defined benefit fund (for example, checking that the assets equal the liabilities, and focusing only on returns, compliance and operational issues). But, Anderson says, defined contribution funds are very different and therefore require a very different approach to ensure that members stay on track for retirement.
Most private sector retirement funds are now defined contribution funds, where members must take the risk that they will have saved sufficient money for retirement. But few members of these funds have any idea whether or not they are on course to retiring financially secure or of the steps they should take to ensure that they do, and neither do most fund members know whether or not they have sufficient death and disability assurance, Anderson says.
Most annual benefit statements simply inform members of their current fund values, how much they and their employer have contributed, and how much investment growth they have received. Although this information is necessary, because it enables members to check the accuracy of the values and it serves as a record of what members have accumulated, Anderson says the information is of little value and as such could contribute to many people retiring without being able to purchase an adequate pension (or having to lower their standard of living well into retirement).
Even a fairly large fund value published in a benefit statement can be misleading, because that amount will often not be sufficient to provide a sustainable monthly pension – one that is comparable to your final pay cheque at retirement, he says.
The conventional approach adopted by trustees of defined contribution funds is to set an overall performance target for their fund, find an investment solution that will meet the target and then to monitor whether or not the target is being reached over a predetermined period of time, Anderson says.
“What this approach fails to address is the reality of why members fail to meet their retirement objectives. The problem in most cases actually lies with how members behave (or do not behave) relative to their retirement planning, rather than how their investments are performing,” he says.
Trustees and employers need to play a far bigger role in addressing the important issues that affect fund members’ financial security, Anderson says. In addition, trustees and employers should provide members with more information, and educate them so that they can understand the relevance of the information, so that members improve their chances of retiring financially secure.
Trustees and employers need to adopt an “outcomes-based approach”, Anderson says.
Trustees spend much of their time on compliance and operational issues and insufficient time on achieving what should be the strategic aim of a retirement fund: a financially secure retirement for members, he says.
Trustees and employers should constantly review employee benefit arrangements to ensure that members’ needs are being met and that shortfalls are being addressed, Anderson says.
For example, he says, you, as a member of a defined contribution fund, should be provided with information that will be of use in calculating whether or not you are on track for a financially secure retirement. The best way to do this is for your retirement fund to provide you with a calculation based on your net replacement ratio – how much money as a percentage of your final pensionable salary you will receive as a pension. You then need to be told what the shortfall is and your options for making up the shortfall.
Employers also have a very important role to play in educating their employees about how they can achieve a financially secure retirement, Anderson says.
Retirement fund members are, in general, not financially literate and they undermine their retirement planning with poor behaviour, he says.
“A framework is required so that those issues that have the greatest impact on a member attract the greatest trustee and employer attention,” Anderson says.
VITAL SIGNS: WHAT YOUR FUND SHOULD TELL YOU
Alexander Forbes says the key information, with explanations, that your retirement fund should on an ongoing basis provide to you, as a fund member, includes:
* An annual projection statement that shows whether or not you are on track in terms of your net replacement ratio (NRR). This statement should also state how much, by way of additional contributions, need to be made to your fund or to a retirement annuity fund, or the extent to which you will need to postpone your retirement, so that you will meet your required or an adequate NRR.
* An annual death benefit needs analysis that shows the level of death benefits provided by the fund compared with the amount that is required for your dependants to be provided with sufficient income.
* Telling you if you are expected to have a shortfall in your NRR. This will allow you to make plans to save more.
* Telling you if, relative to a reasonable benchmark, you are expected to have a shortfall in your death, disability or other benefits. This information will alert you to the need to make up any shortfall by buying additional risk assurance.
* Telling you how your financial security in retirement will be affected if you do not preserve your retirement savings if you leave the fund before retirement, ideally based on your actual information.
* Telling you, long before your date of retirement, what pension you can expect based on actual quotations from the market (showing pensions under different options).
* Telling you if your investment option may be inappropriate. For example, you may have chosen a cash portfolio while you are relatively young or have switched to a high-risk investment in the hope of earning better returns, particularly when you are close to retirement.