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Retirement Planning
Thursday, March 1, 2012
Future nest

Government could be overburdened by old age grants. So where is your pension coming from?


If you answered: “the government will look after me in my old age”, you would be wrong.
There are no government pensions in South Africa. So the onus is entirely on the individual to provide for his retirement.
A state pension, as paid in most European and Anglo-Saxon countries, does not exist. “Even those aren’t meant as the sole source of income, but rather part of the solution. Individuals are expected to play their part by saving privately,” says Steven Nathan, CEO of 10X Investments.
In South Africa, there is a general misconception about a government pension. A state pension is different from a government employee’s pension, which is a pension scheme for government employees. It is also confused with an “Old Persons Grant”, which is actually poverty relief for older people, not a pension. It is a minuscule at R1 140* pm and only available to individuals over 60 earning less than R44 880 pa with assets currently less than R752 400 in terms of the 2011 Budget. This poverty relief is hardly enough to cover anyone’s basic food needs. (*increased to R1 200 in the latest 2012 Budget – though, at time of writing, no updated thresholds could be found, even on the official SA Social Security Agency website [and nationwide all their contact numbers were unable even to take messages as the ‘message boxes were full!]).
The government does provide tax incentives to encourage people to save. However, only around 15% of SA’s population contributes to a retirement fund. Further, according to industry estimates, half the people who contribute regularly to a retirement fund end up with a final income replacement ratio below 30%. The recommended minimum is 60%.
“Using tax breaks to encourage individuals to provide for their own retirement has clearly not worked. It has not delivered financially independent pensioners,” notes Nathan. “Many of these pensioners will eventually turn to the state for support and sadly they’ll find no assistance.”
Who suffers? Almost everyone. Those who haven’t saved enough, their dependants, those who need to cover some of the shortfall, the state which has to divert extra funds to old age grants, and taxpayers who receive declining services. No one benefits from the current system except the retirement industry, which, in the main, earns excessive fees from retirement investors.
Fundamental change is needed to stop the ineptness of SA’s retirement investment system.
“SA needs compulsory retirement saving for all who earn an income,” contends Nathan. “South Africans don’t have a strong savings culture,” he observes. “We start too late, we contribute too little, we cash in our retirement funds too early, and we opt for the cash lump sum at retirement, rather than a guaranteed annuity.” Reasons for this include ignorance, apathy, poor discipline, hubris and misplaced trust in the government and relatives.
But individuals aren’t solely to blame. Many are overwhelmed by an industry that provides too much choice and complexity, charges excessive fees and offers poor transparency.
Compulsory saving is only the first step. The next is to select an optimal investment solution.
Here Nathan recommends a sensible, low-fee solution starting with minimum contributions that grow over time; coupled with compulsory preservation until retirement and the binding purchase of an annuity income pension at retirement.
Nathan isn’t the only one promoting this model.
A similar system already exists in the UK. NEST (National Employment Savings Trust) is part of the UK’s pension reform, based on compulsory enrolment and employer contributions. Its default features include transparent reporting, life-stage asset allocation, passive investing, low fees and portability (the opportunity to keep saving and contributing to the same fund on changing jobs or becoming self/unemployed).
Nathan is adamant that this is the solution SA investors need. In fact, 10X already provides this structure to investors. To work in practice, he endorses a single, flexible solution - one that works for most savers. “Offer the same solution in all formats - pension, provident, retirement annuity (RA) and preservation - so members can shift seamlessly from one fund to another without charge or change to their investment strategy, and without risking time out of the market.”
To ensure an individual result, rather than an average outcome, Nathan advises a lifestyle model that invests members according to their specific time horizon. It requires a growth phase with a high equity component and a consolidation phase with declining equity allocation, for those who face conversion risk at retirement, by opting for a guaranteed annuity or cash lump sum.
Low fees are critical. Ideally, Nathan cautions that fees should not exceed 1% pa over a full investment term. Presently, the average cost of investing in South Africa is north of 2% pa. If you think that 1% difference in fees is small, think again. A balanced portfolio is likely to earn no more than a 5% pa return after inflation over time. Every 1% saved increases the long-term investment result by around 30%.
To keep fees low, Nathan advises a passive investment strategy, using a direct investment model into a large fund. Passive investment simplifies administration and increases savings. Active management fees and risk are cut without giving up performance. “The market return outperforms most actively managed funds over time. Active management is a zero-sum game before costs and a losing game after. Most actively managed funds eventually lag the market return,” explains Nathan. In a recent Profile Data survey, 95% of general equity fund managers failed to beat the market after costs over twenty years.
Cut out broker fees by using direct investment and you create another big saving.
The next step is to consolidate funds. Research shows bigger is better when it comes to pension funds because they achieve greater economies of scale, lowering the average cost per member and extracting a higher net investment return. “With 3 200 stand-alone funds, SA still has far too many for its pool of retirement investors. Most participating members would be better served with an umbrella fund,” he says.
Finally, improve disclosure and appoint independent boards of trustees and create the necessary regulatory overlay: auto-enrolment, compulsory contributions, employer-matching and forced preservation.
“Whether our government will take the steps needed for compulsory retirement investment and put the regulatory framework in place for a system like the UK’s NEST is yet to be seen,” says Nathan. “However if it wishes to avoid a massive overload in old age poverty grants, and other crippling pressures, it should waste no time doing this.”
For more information visit www.10X.co.za, call 0861 109 109 or contact info@10X.co.za
 

Copyright © Insurance Times and Investments® Vol:25.3 1st March, 2012
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