Retirement outcomes in South Africa are very poor. National Treasury estimates that 94% of members in employer funds are not on track to achieve desired retirement outcomes. There are several reasons for this, including the macroeconomic challenges facing our society, which increase the need for take-home pay and limit opportunities for additional savings.
Blessing Utete, Managing Executive at Old Mutual Corporate Consultants (OMCC), says that while there are several factors which contribute to poor outcomes, fund design is a challenge. ‘Funds are not always designed appropriately to achieve the right results for members,’ he says. ‘It’s not a governance issue, but rather speaks to how a board, management committee or employer has designed and set up the fund.’
‘There are six significant factors – or levers – behind why people are not able to retire comfortably, and those are what OnTrack™ measures to help recommend design revisions for better outcomes,’ says Utete.
The five levers are:
1. The type and price of a pension being bought at retirement age
The price of a pension at retirement age, which is the cost of converting retirement savings into an annuity, is crucial for determining retirees’ income streams. These annuities come in various forms, each offering different benefits, risks and costs. The choice of annuity significantly impacts the financial security and quality of life for retirees, making it a crucial factor in retirement fund design.
The primary types of annuities include guaranteed annuities, living annuities and hybrid annuities, which encompass a combination of a guaranteed portion and a pool of assets from which a member may draw down. Each type serves distinct needs and preferences, affecting the price and the retirement income they generate.
2. Pensionable salary
Pensionable salary is the portion of an employee’s earnings used to calculate retirement contributions. It plays an important role in determining retirement savings. Higher pensionable salaries, with regular and equitable inflation adjustments, lead to increased contributions from both employees and employers, boosting retirement fund growth.
Decision-makers are also encouraged to explore inclusive pensionable salary definitions that consider bonuses, commissions and overtime to provide support through clear communication and regulatory compliance, and to maintain transparent employee policies for efficient planning.
3. Percentage of contribution
Contribution rates, by both employees and employers, are vital in shaping the adequacy of retirement funds. Default contribution levels and the design of contribution categories by employers have a significant impact on retirement outcomes. Higher contribution rates directly correlate with increased retirement savings accumulation, thereby enhancing future financial security for employees.
Strategic considerations such as automatic enrolment and escalation mechanisms, employer matching programmes and educational initiatives on the benefits of higher contributions play crucial roles in promoting optimal contribution rates. These strategies not only encourage proactive retirement planning, but also foster a culture of financial preparedness among employees.
4. Investment strategy
The setting of the investment strategy in retirement fund design refers to the approach taken to allocate and manage assets with the goal of achieving optimal returns while managing risk. This strategic decision is key in determining the growth and sustainability of retirement savings.
A well-constructed investment strategy considers factors such as risk tolerance, time horizon and market conditions to effectively balance growth potential with the preservation of capital. Strategies may include diversification across asset classes, active or passive management styles, and the use of target-date funds tailored to retirement timelines.
By aligning investment strategies with the specific needs and risk profiles of participants, retirement funds can enhance long-term financial security by achieving the required investment growth over time. Regular monitoring and adjustment of investment allocations ensures alignment with evolving market dynamics and participants’ changing needs, thereby optimising retirement outcomes and mitigating investment risks.
5. Normal retirement age
Setting the normal retirement age of a retirement fund is a critical factor in design, as it represents the time frame for saving until retirement and directly influences all participant outcomes. The decision on when employees can retire impacts both the accumulation phase, where contributions grow through investments, and the distribution phase, when savings are drawn upon for income.
A longer time until retirement allows for greater contributions and potential compound growth, bolstering retirement savings. Strategic retirement age policies, such as offering flexible retirement options and incentivising later retirements, can optimise retirement outcomes by aligning savings accumulation with longer life expectancies and changing economic conditions.
While occupational retirement funds remain one of the largest sources of private retirement savings in South Africa, and can provide significant benefit to employees when suitably designed, members’ savings success can vary, depending on factors such as the level of employee and employer contributions, investment strategies, the flexibility of member choices and the defaults of a fund.
‘These design factors have a statistically significant effect on member outcomes,’ says Keri-Lee Edmond, Consulting Analytics and Insights Manager at OMCC. ‘Firstly,’ says Edmond, ‘most retirement professionals recommend an ideal replacement of income at the time of retirement to be around 70% to 75% of one’s working salary. What many people underestimate is the amount of savings required to sustain this level of income for your entire post-working phase, which is usually around 11 to 12 multiples of your annual salary if you retire at 65, and even more if you’re planning to stop work before then. However, many fund defaults are designed to deliver a significantly lower replacement ratio than the ideal 70% to 75%, and many employees remain in these defaults.’
The second factor is member choice. ‘For example,’ says Edmond, ‘employees might actively select the lowest possible retirement contributions to maximise their cash receivable or opting into investment strategies that do not match their age or risk profile.’
Who fixes a broken fund?
Globally and in South Africa, the onus of retirement savings has been shifting considerably towards individuals, placing an increased responsibility on citizens to manage their own retirement funds, whether through their employer fund or outside of it.
Edmond says that if an individual belongs to a fund that doesn’t target their ideal level of retirement savings, there are several ways they can supplement their employer fund, including increased employee contributions, additional voluntary contributions, personal retirement savings plans, additional investments and assets, savings vehicles and financial planning. ‘By taking proactive steps to supplement their employer fund, individuals can enhance their financial security in retirement and ensure they have enough funds to support their desired lifestyle,’ she says.
There are other issues around governance, and how fund operators communicate with members – and behavioural science also plays a role. ‘Communicating certain elements as “opt-out” rather than “opt-in” helps members make better conscious choices,’ says Utete.