1 September 2024 marks the commencement of the Two Component system. It is one of the most significant reforms to the retirement fund industry in decades and undoubtedly, many working in, and for, this industry are feeling a bit overwhelmed and nervous, given the volume of Two Component related matters they already had to deal with; and considering what is yet to come. However, despite the onslaught of work, it is encouraging to witness the sheer amount of positive engagement, effort and resolve that has been demonstrated by industry stakeholders to prepare for its implementation – clearly demonstrating support of the system and its objectives, even if there have been disagreements on certain aspects thereof. There appears to be a common understanding of the importance to retirement fund members and that funds and providers, both in the public and private sectors, must get it right.
The road so far
The Two Component system has far-reaching implications for all those affected by it. Various entities, representing different industry stakeholders, have frequently engaged to facilitate consultation and consider inputs, and to ultimately establish the regulatory framework in its current format. Discussion are ongoing and future refinements are expected, but there is a framework for implementation.
Pension fund administrators and consulting firms have spent countless hours preparing – upskilling staff, bolstering resources, reconfiguring administration systems, updating processes and reports, introducing new procedures to allow individual fund members to interact directly with funds to request payment of their savings component withdrawals, providing guidance and advice to trustees, management committees and members. Retirement funds, like service providers, have been hard at work preparing, updating documents and reviewing rules. Similarly, the FSCA, PFA and SARS have been preparing. Overall communication efforts so far are commendable – there have been conferences, newsletters, articles, brochures, videos, webinars, road shows and tools to explain the new regime to members, consultants and advisors.
And what about the retirement fund actuaries? Spending a considerable amount time figuring out how the Two Component system will apply to defined benefit (DB) funds, hybrid funds and funds with DB elements, such as self-insured death or disability benefits. There is often an assumption that DB funds are a thing of the past, but several private sector funds remain, not to mention the largest pension fund in Africa, the Government Employees Pension Fund, with more than 1.2 million active members according to its website.
So, what is different for defined benefit funds?
The overall objectives are the same. From 1 September 2024 onwards, DB fund members will have a saving component accruing and must be given the option to access it once a year. Also, a retirement component that must be preserved till retirement will accrue and vested interests as at 31 August 2024 will be ring-fenced. Access and tax rules, as they apply to defined contribution (DC) funds, will be the same for DB funds.
However, in DB funds it is not the retirement funding contributions that will be accruing in the new components, but rather the member’s pensionable service. Pensionable service will be split 1/3rd and 2/3rds between the savings component and retirement component respectively, i.e. for every year of pensionable service accumulated after 1 September 2024, the member will have 4 months of pensionable service added to their savings component and 8 months to their retirement component.
The available benefit per component will be based on the accumulated pensionable service in that component and applying the fund’s benefit formulas. Service will be added over time and similarly if there are withdrawals from the fund, the service equivalent of the amounts withdrawn will be deducted. The respective components will therefore build up in pensionable service terms from 1 September 2024 as follows:
Sounds simple, but it gets more complicated
The principle of splitting service after 1 September 2024 is reasonably straight forward but translating that service into a benefit entitlement by applying a benefit formula is not. In DC funds a member’s fund benefit on leaving the fund, for whatever reason is typically equal to his/her accumulated fund credit. The benefit structures in DB funds differ depending on reason why a member leaves the fund; they differ between funds; and they are generally more complicated.
Some funds, for example, offer members a pension at retirement. The member can commute up to a third of their annual pension benefit in cash, and the residual pension will be reduced to 2/3rds of the original pension. Other funds, like the GEPF, provide a pension benefit, that cannot be taken in cash, as well as a lump sum gratuity benefit which represents a member’s cash entitlement from the fund on retirement. The gratuity benefits do not necessarily represent exactly a third of the total benefit and members are not strictly speaking entitled to 1/3rd of the retirement benefit in cash in the current regime.
Resignation benefits, as another example, also differ. The GEPF offers a cash benefit based on salary and service, subject to a minimum of the members’ actuarial interest as defined in the statutes governing the fund and determined by the actuary. The actuarial interest represents the member’s benefits in the fund. DB funds that are governed by the Pension Funds Act must pay a prescribed minimum benefit to a member on withdrawal – referred to as the minimum individual reserve. Some funds therefore offer the minimum individual reserve on resignation, but others provide for a withdrawal benefit that is equal to the higher of the minimum individual reserve and actuarial reserve value. The actuarial reserve value, like the actuarial interest referred to above, represents the amount that the fund holds to cover a possible future benefit payment on the member’s behalf.
Actuarial factors are needed to perform the above-mentioned calculations. These factors are determined based on a range of best estimate economic and demographic assumptions, such as future investment returns, salary inflation rates, early withdrawal rates, mortality and morbidity assumptions. These assumptions are collectively referred to as the statutory valuation basis and the basis is determined by the actuary when performing the fund’s statutory actuarial valuation. A basis can change, often driven by changes in the economic indicators as well as other observed changes in the demographic experience (for example mortality improvements over time), which will impact benefit calculations.
The definition of pensionable service that funds apply may also have to be reconsidered, for example where a fund previously considered only completed months, it may have to consider service in days or smaller units – given that seed capital allocation may be very small for members with large benefits.
Suffice to say, DB funds have many moving parts and benefit values under the Two Component system are not intuitive to derive. Actuaries must play an integral part in providing guidance to DB funds and their members, assisting with benefit calculations and keeping track of members’ various benefit entitlements per component over time.
Getting by with a little help
Members will need help to understand their benefit entitlements and make informed financial decisions going forward. This is true for both DB and DC members.
Although the benefit values are easier to understand in a DC fund, there are still more options and more rules that apply on how the benefits may be accessed and when. There are tax consequences to consider and going forward, a member will at least have a retirement component that will have to be transferred or preserved in fund. It is a tricky landscape to navigate, and members will need help.
We refer to it by different names – financial advice, retirement benefit counselling, financial coaching, member engagement, – but it ultimately boils down to the same concept. Help. Those who are able, and accredited to do so, must offer help. The system was complicated before. It is about to become next level complicated. But ultimately, members should see improved outcomes and with some help, members could benefit more.
Hopefully in time all will come to understand the opportunities that the new regime present. The ability for advisors and members to connect frequently. Access to emergency savings, retirement savings and a level playing field across funds. The game has changed, and if properly coached, more individuals can participate and emerge victorious.