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Why it’s so difficult to solve the retirement puzzle

How do you get someone to sacrifice something today so they can have something better tomorrow?

“When I said, ‘Til death do us part’ when I was 25, I didn’t realise I was going to live to 100.”

This was the tongue-in-cheek comment from a financial planner when the issue of longevity came up during a retirement discussion.

It is a subject not only married couples may be grappling with. Regulators worldwide are finding it difficult to reform retirement systems in a way that will allow people to support themselves when they are living much longer than in previous decades. In Japan, the old-age dependency ratio – the number of people older than 65, compared to those of working age – has increased substantially over the past 20 years.

Apart from increases in longevity, countries may also face structural issues that could make it difficult to come up with solutions. In South Africa, an unemployment rate of 27.5% makes it impossible to enforce a basic level of retirement saving. Compulsory preservation of retirement savings is a pipe dream. Over the last few years, local retirees have also had to grapple with dismal stock market returns, which made it very difficult to stay ahead of inflation. 

Is there really a crisis?

How bad the retirement situation really is, is difficult to quantify. Commentators often say that only 6% of South Africans can maintain their living standard in retirement, but no one seems to know exactly where the 6% figure came from. Discussions with industry insiders who have been around the block suggest that this figure was already cited decades ago.

Findings from the Alexander Forbes Retirement Fund Member Watch suggest that only 5.2% of those who retired in the year through March 2018 were able to replace 80% or more of their last salary from their pension fund benefits. Because fewer than 10% of members preserve their benefits when they change jobs, the assumption is that in most instances there are no other savings available from which to draw an income in retirement. Yet even then, income may not be a good indication of people’s actual expenses in retirement.

Regardless of what the actual number is, various surveys and studies support the notion that most South Africans won’t be able to maintain their standard of living in retirement. In one recent study commissioned by Just, over one third of people said they couldn’t afford to lose any of their retirement fund money before it would seriously affect their retirement plans.

Why it’s so difficult

There are various reasons for the difficult situation many retirees find themselves in – non-preservation, low contribution rates, poor returns and high fees are just some of the problems.

The trouble is that saving enough for retirement effectively requires people to forfeit something today in the hope of having something better tomorrow. This becomes increasingly difficult in an environment where they may have lost their job and may need their pension to survive, or where they are just generally struggling to make ends meet. Figures from FNB Retail suggest that roughly 56% of middle income consumers (those who earn a gross monthly income of between R7 000 and R60 000) spend all their monthly income in five days or less after receiving it.

If getting by today is already a challenge, then planning for a better future seems an unrealistic expectation.

The introduction of treasury’s default regulations is an effort to address some of these issues by nudging people in the right direction. The approach is grounded in behavioural economics, something financial services group Discovery has had great success with. A recent study showed that Vitality’s shared-valued insurance model combined with Apple Watch have led to a sustained 34% increase in people’s physical activity levels.

The Discovery model rewards people who exercise regularly with weekly smoothies and monthly cashbacks. Ultimately, the expectation is that people will also benefit in the long run as they will be healthier, but the ‘benefits’ already become ‘visible’ after one week.

The problem with getting people to save for retirement is that there is no smoothie or movie ticket if you don’t cash out when you change jobs. Effectively, people need to make a sacrifice today (save more and spend less) to have a better future tomorrow. While the tax-free contribution to a retirement vehicle and tax-free compounding within the vehicle is a powerful incentive on paper, it is often invisible to the average pension fund member.

Retirement benefits counselling

It is in this area where retirement benefits counselling – which retirement funds will be compelled to offer from March 1, 2019 – can make the biggest difference. One industry stakeholder who is actively involved in the benefits counselling area says they can already see an improvement in preservation as a result of the counselling process, which highlights the punitive taxes that have to be paid if people cash out their benefits (immediately and at retirement).

The question is how funds will approach the retirement benefits counselling (the regulator has not been prescriptive as to how this should be done) and how it may impact the results over time.

For funds, the challenge is to demonstrate the impact of tax-free compounding over a 40-year savings horizon in such a way that people can see the ongoing benefits of consistent sound financial decision-making – not only at the point of retirement, but today.

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Why is it impossivle to enforce compulsory retirement contributions?
We have the absurdity of minimum wage, the opportunity to introduce mandatory savings would have been now.

Yes it might hurt in the short term but eventually people adjust. The human animal is remarkably resilient.

Of course, it would be easier to do if income taxes were more reasonable. And if pensions were allowed to invest more offshore returns could be better.

Pension savings could also be made moee useful in the short term — for every 500k tou saved up you are allowed to access 2.5% for emergencies. Oh some peoplw will waste it but i think most wont. Or you can restrict it to medical and debt emergencies only.
And why not give people an incentive to use a part of their savings as a home loan deposit if they hit a minimum amount?
There are ways to make saving for.retirement more appealimg, and useful.
Another way is to phase out state pensions.
For a lot of people in SA the plan is the state dole and their kids. Remove the crutch.
Is my opinion amyways.

The challenge (or problem rather) is also the impact of 20% dividend tax compounding over a 40-year savings horizon, and this continues after retirement. This has been increased from 15% to 20% recently. There seems to be a bit of a conflict of interest between the saving campaign and the gaining campaign in SA.

There’s no dividend tax in a retirement fund.

Yes, but people have “life savings” for retirement in addition to “retirement funds”, having a standard retirement fund is not enough nowadays, you need to save in addition to it, and pay dividend tax.

@Ludwig, 27.5% savings in a retirement fund should be enough to retire at 60/65? In fact, likely sooner.

Add to that TFSA, as well as the tax free interest portion, a portfolio of REITS that switches to income tax, and it’s likely you won’t need to pay the onerous 20% divi tax?

Ahh, yes, cv63, but….

Many of us retirees cannot rely purely on a “retirement fund,” we have had to save and put money into other investments.

Still, the fact remains that the 20% tax on dividend & interest is onerous for the aged.

I would like to see that dividend tax is reduced by age breaks, say something like 15% for those over 55 years of age, 10% for over 60, 5% for over 65 and 0 for over 70.

Are unit trust (equity) funds held in a living annuity subject to dividend tax?

The problem is that most people would have failed the marshmallow test as children and have not seen the light as adults. They cannot delay gratification and they equate their self worth with their image and possessions. Hence the purchasing of the latest cell phones, fitness watch and car on credit. The basic rule that should be followed is that if you cannot pay cash for something you cannot afford it. It is so simple but takes discipline. But the rewards are huge and once a person understands the true beauty of compounding there is no turning back!

Exactly. But there is also an extremely strong culture in our Western society that your worth as person is measured by your possessions hence the bigger the car the the more important you are.People who get captivated by this lethal Siren’s song drive around in an expensive car for a few months but end up wrecked on the financial rocks of life.

To me there are primarily 2 flaws in retirement savings one is the option to commute 1/3 of ones pension on retirement – this should be stopped poste haste as invariably these funds are just blown away on non essentials. The other inhibitor is the fees within an R.A. and the resultant L.A. and the fact that you are compelled to draw against the L.A. at 2.5% per annum – why, if this L.A. is your back up plan for many years in the future and you can come out on your present pension, then why compel the retiree to draw down on the L.A. – no draw down = growth for the future, and a pension top up

You should take R500k tax free in order to reduce your pension thus paying less tax.

Allow people to reduce their LA drawdown to 0%. Then they can convert their RA to an LA at age 55. This will help to get out of the regulation 28 requirements.

Why make the RA (or any other retirement fund) a LA if it’s a backup plan? Just keep it as it is until you want to make it a LA. And there are cheap RAs, even managed ones.

why not confront the elephant? Inflation and currency devaluation make savings (for the few who can afford them) seem worth less tomorrow than today? Or is it only portfolio managers who comment here?

I didnt think anyone here is a portfolio manager?

Inflation linked bonds.
Usd dollars or gold

Those are purely hedging assets, not ideal for wealth creation.

Inflation-linked bonds are expensive and do not protect against “real” inflation i.e. each individual has their own inflation depending on their spending. They do not provide real returns, only real capital value retention. Any CPI+ links are even more expensive. Less fees and its a no-go.

USD – forex fees, no dividends.
Gold – commodity, dangerous game, usually stable but not good for wealth building, solely capital preservation – no dividends either.

All hedging strategies are costly and end up “guarsnteeing” a real loss (but limits the loss)

Sorry just my opinion.

@thebrus — nah, no apologies, swapping opinions and learning from one another is why i read the comment threads and one of the nice things about this forum.

I am a little puzzled by what rtnaami was asking but since he mentioned currency devaluation i assumed it might be defensive strategies which is why i mentioned ilbi and usd.
As you correctly stated, these are pure defensive plays and not at all about maximising returns. There is a place for them but it might not be for everyone.

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