How to make your pension piggy bank squeal with delight
Alexander Forbes has made illuminating findings about how people handle their pension funds
Alexander Forbes has done the widest survey of the health of retirement funds and their members. Its annual Member Watch for the first time included more than one million clients belonging to the group’s 2,030 employer clients.
As Forbes head of client coverage John Anderson puts it, for many a pension is their only form of long-term savings. But to live comfortably in old age there needs to be a sufficient and consistent level of contributions and an appropriate level of investment return after fees.
To make these contributions affordable, there should be steady progress in the member’s salary. Pension funds also need to make deductions for group life and disability cover, in the event of the members not being able to finish their career or support their families.
But it is equally important for members to preserve their fund credits, and this has recently been made easier as accumulated capital can now stay in the fund after resignation, and the members can change their status to paid-up.
Up to 27.5% of total income is tax deductible if it goes into a retirement fund and/or retirement annuity fund.
Anderson says members need to contribute at least 17% to their funds for 40 years to achieve a comfortable retirement.
This is defined, at least by most consultants, as a 75% replacement ratio – your pension will be three-quarters of the amount of your final salary.
If the contribution is 11% from the age of 20, even if paid religiously through an entire career, and in spite of what you have read about compound interest, the replacement ratio will be barely 40%, and even at 13% the replacement ratio will be just 50% of final salary.
To achieve the magic 75% number Anderson says members need a fund credit of at least 12 times pensionable salary. But in the Forbes database the average contribution was 4.96% from members and 9.15% from the employer. After expenses and risk cover costs of 3.22%, the average contribution is just 12.17%.
The gross contributions for Alexander Forbes’s public sector clients, at 23%, is much higher than for any of the private sector industries, which range from 15.9% in fishing, forestry and agriculture down to 11.5% in professional and business services – presumably the latter are believed to be qualified to fend for themselves. Fishermen, however, get one of the lowest death benefits at just over one times salary; retail, manufacturing and construction all get 2.5 times salary.
The average actual replacement ratio was 28.8%. Anderson says only 6% of members can expect to reach that magic 75% replacement ratio level.
There is one simple, but not necessarily desirable, way to increase the replacement ratio: delaying retirement.
Staying on to 65 instead of leaving at 55 can double the replacement ratio, both through further contributions and because a pension isn’t yet being paid out.
Members can destroy value by making changes too frequently to their investment portfolios, but in fact less than 1% of members made investment switches over the year to March 2018.
Only 85 (and I mean 85 not 85,000) of the 1 million members made six or more switches to their portfolio, which would qualify as somewhat reckless market timing. Only a minority of them would have done these switches without consulting an adviser.
If anything, members are too conservative. Out of the 14% exercising choice under 55, almost 40% opt for a portfolio with less than 50% in equities, and 10% portfolios with no equities – even though with the luxury of time investing in risky assets such as shares makes sense.
Baby boomers are still embracing risk, which makes sense given that with their increased lifespan many could spend 30 years in retirement. About 30% of over-60s who are still working are invested in medium to high-risk portfolios. It makes sense if they are planning to move into equity-rich living annuities when they retire.
Low preservation rates remain a more important issue.
When I left my first job I am not sure preservation funds existed, and the personnel department made no effort to educate us about them if they did. We were given a cheque on our way out of the building, which didn’t even include the company contributions.
Now if we don’t request otherwise our capital will be left in the fund, particularly for people who won’t automatically join another employer’s fund. But unfortunately, if we are under 35 and told we can have R30,000 to R50,000 cash in hand with bills to pay, rather than saving it for a notional date many years in the future what decision are we going to make?
Members are certainly voting with their feet. The proportion of members who preserve has fallen from 11.5% in 2012 to 8.7% in 2018. The weaker economy has clearly played a part.
The figure does not look quite so bad expressed in assets. A higher proportion of members with large credits preserve, but even here asset preservation has fallen from 50.6% to 48.4%, less than half. And preservation rates increased with age – more than 97% of people under 25 cash in and this falls to 61% for the over 65s.
Compulsory preservation is a political hot potato. Almost all stakeholders claim their members “need” the money. The system of state grants may sideline that argument. The taxman makes it very attractive to keep contributions in a pension fund, as all investment growth is tax-free.
Perhaps the tax on withdrawals should be more punitive. Withdrawals up to R25,000 are tax-free, and the balance up to R650,000 is taxed at a preferential 18% rate.
It is perhaps not too surprising that retail, wholesale and hospitality are the worst preservers at just 4%, since they have a culture of casual work.
Curiously, energy is by a clear margin the most responsible sector, with a 17.7% preservation rate, perhaps because they live with the uncertainty of the oil price every day and need a security blanket. It isn’t clear where people who work for energy companies and work in retail forecourts fit into this matrix.
Excluding energy, the public sector is a better preserver than the private sector.