There was a time when many South African employers offered their employees guaranteed pensions when they retired.
These were called ‘defined benefit’ pension funds. The defined benefit was usually a formula that promised employees 2% (or a similar percentage) of their salary for every year they worked for that employer. An employee who worked for such an employer for 40 years would therefore receive a pension of 80% of their salary when they retired. The salary figures that were taken into account usually excluded bonuses and allowances. This pension was guaranteed by the employer. The employer and employee both contributed fixed amounts each month to such funds.
Every three years the actuary to the pension fund would value it to see if it had enough money to make good on the guarantees. If there was insufficient money in the fund, the shortfall would be made up by the employer who, after all, had guaranteed the benefits. So they employer took responsibility for the financial risk and the employees knew exactly how much pension they would receive.
‘Defined contribution’ funds mean less certainty
From the late 1970s until now these funds have mostly been shut down and their values transferred to what are called ‘defined contribution’ funds. In this arrangement, both employer and employee make fixed contributions to the pension fund. These fixed contributions are percentages of the individual’s salary. When a member reaches retirement they will only have the amount of money in the retirement fund at that time to retire on.
So the full investment risk of retirement has now been transferred to the employee. Unfortunately that employee has no way of knowing whether or not they are saving enough to ensure a comfortable retirement. Most assume that the pension fund will see them right if they belong for long enough, but this is a flawed belief at best. This problem extends from CEO to general worker.
Richard Glass, an American pensions writer, put it this way in 2010: “The process workers should utilise in determining their retirement income needs and funding requirements is essentially the same as that used by large defined benefit plans in determining their liabilities and contribution requirements. Unfortunately the average worker is ill-prepared to take on this task. To make matters worse, [they] are unfamiliar with the magnitude of the problem.”
Few even realise that a problem exists
People who manage retirement funds are responsible for making sure that the funds run like clockwork and comply with all legal requirements. They are also responsible for providing members with appropriate information about the fund. That information is not knowledge.
The next logical step for most people is to approach a financial advisor. Sadly most advisors are only interested in dealing with what is politely called ‘high net worth individuals’. Further, financial advisors are neither inclined nor trained to educate people. They may have the finest intentions, but they are conflicted because their income comes from annual fees paid on products they are able to convince individuals to invest in.
Clearly, members must be able to understand their situations well enough to make informed financial decisions. And for this they need education, and especially education from unconflicted sources.
John Anderson, a well-known actuary in South Africa, had this to say in a note published in 2012: “There are insufficient support structures in place to help members make the right choices. Instead of leaving the members of retirement funds to their own devices, more should be done to educate them so that more South Africans can maintain their standard of living in retirement.”
It thus makes sense for education in this area to be provided as an employer initiative.
Teaching employees how to integrate their company provided benefits into their personal financial lives improves their chances of having a financially comfortable retirement.
If individuals understand how financial products benefit them there is less chance of them falling prey to exploitation at their most vulnerable, when retiring or being retrenched.
How does a company benefit from paying for the education of its workforce in regard to the benefits they receive? The answer is simple: engaged employees have greater goodwill towards their employer. They put more effort into the achievement of business objectives.
Rod Burn, former director of operational performance at PPC, actually measured this effect using an anonymous internal perception monitor. Because of the very positive results in this area he remains curious as to why this aspect of training has been so widely neglected.
People who understand how to create their own wealth have motivation to optimise it.
While the basics are simple, and the costs of such education are minimal, and the benefits to both employee and employer are substantial.
* Dave Crawford is a certified financial planner and founder of retirement training firm Planning Retirement.