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What income are you targeting in retirement?

The case for a goals-based approach.

JOHANNESBURG – One of the biggest challenges in the pension fund space is the lack of a clear income goal for retirement, an industry expert argues.

Shaun Levitan, chief operating officer of liability-driven investment manager Colourfield, says most defined contribution funds in South Africa lack a clear income-goal focus for individual members.

“If you are in a fund, do you really know what you are on track for [to receive as an income in retirement]?”

He says fund members are confronted with a piece of paper that shows their total fund credit at the beginning and the end of a particular investment period. But unfortunately this often creates a situation where people are trained to think of their pension fund in a similar manner to their bank account (which also reflects the money available at the beginning and the end of the month including deposits and withdrawals).

Levitan says as a result pension fund members often feel their pension fund credit is within reach.

He believes that the behaviour of pension fund members could change for the better if they considered their retirement savings in terms of an income target and not one large pot of money.

Ultimately members join a retirement fund to get a stream of income that will enable them to maintain their standard of living in retirement.

“We are used to thinking of life in terms of what expenses can be met from income and it is no different when you get to retirement,” he says.

While actuaries working in a defined benefit environment (where the benefit is guaranteed and the employer carries the investment and longevity risk) have used a liability-driven investment approach to address investment risk for many years, in the context of individual fund members in a defined contribution environment (where members carry the investment and longevity risk) the term goals-based investing is more prevalent.

But these are really two sides of the same coin – there is an explicit recognition that what you are trying to meet is a liability or goal and to make sure that you are best positioned to meet that goal. For individual members in a defined contribution fund, this goal is targeting a specific income in retirement, he says.

How much income do I need?

Levitan says the reality is that most people are unengaged with their retirement in the early stages of their careers.

People in their thirties can’t be expected to know how much money they need in retirement. Moreover, any good retirement system would do that on their behalf, he says.

Ultimately, there does come a point where people do become engaged.

“At that point you really want the tools to be available for them to be able to do more than what is really a default that is being chosen by a board of trustees.”

But what members can do is to recognise that there is a liability (the income that they need in retirement) and acknowledge that their asset is the level of contributions they will be making into the fund (on top of the current fund credit) to get a better representation of their own balance sheet.

It is fairly easy for an actuary to calculate what the cost would be of buying an annuity at some future date that would provide for a particular level of income (the liability that the member is trying to meet). The actuary would also be able to determine whether the specific member is on track to buy that income, considering the current fund value and contribution levels at various points along the way to retirement, Levitan says.

For example: The individual might need R25 000 a month in retirement, but is only on track to get R12 500.

This would create a much more sobering picture than an aggregate fund credit (a million or two often looks like a lot of money, but in a retirement context it is not) and could act as an incentive to save more, retire later or to take on more investment risk.

“Why would you save more if you didn’t know why you needed to save more?”

Apart from the clear focus the goals-based approach provides the member, it could potentially also reduce the risk in the portfolio.

Levitan says if the calculations suggest that investing the fund credit and future contributions in a risk-free asset would guarantee a 75% replacement ratio (an income of 75% of the member’s final salary, assuming that is the targeted income), theoretically the question becomes why the member would still want equities in the portfolio.

“The reality is that if I look at the real return of 2% on inflation-linked bonds it is never going to be enough to reach most income goals for younger members unless you are contributing at a much higher rate.”

But by matching the investment strategy to the specific income requirement in retirement, the member would get a real understanding of why a certain equity exposure may be necessary, he says.

Levitan says by following a goals-based approach the individual would be less concerned about a sell-off in equity markets because he or she would understand that it was the only way to reach the income goal over time.

While a selloff in equities may have a detrimental impact on the fund value in the short-term (if the exposure to equities was meaningful), if real rates on the long end of the curve went up as well (as was the case on Black Monday late in August) the cost of the annuity would become cheaper.

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It is not the responsibility / nor the ability of the Pension Fund to tailor investment needs / or contribution rates to the individual.
This remains the responsibility of the individual.
Unfortunately the average SA employee is more in touch with the latest smartphone, flat screen and BMW. That is where the “retirement money” is going.
The buck stops with the individual and they blame everyone but them self!

Its quite scary and i can understand why many pensioners end up destitute.

For me, at 43, my goal is to have a decent medical aid, paid off car and paid off property at minimum…as a luxury i would consider an annual holiday to the coast for example. I doubt 90% of pensioners in this country can afford that. Looking at Aus, Canada, NZ where i have family and friends, it seems that this is would also be considered a luxurious retirement for most.

I believe that to live frugally during your working life and saving as much as you can, without being a Scrooge, will lead to a more comfortable retirement. My folks are a good example whom i look up to and try emulate. I never went without the basics but we didn’t waste money and now they can live a relatively decent retirement.

simply cannot compare retirement planning in sa to that in nz, canada or aus. in these 3 countries one has access to world class free medical care AND a govt pension which altho’ not fantastic will provide one with a standard of living well above existence level. certainly in aus most people do not use their employers to look after their retirement planning – they do it themselves in “do-it-yourself” (retirement) plans (trusts). this means individuals are taking responsibility for your retirement. the UK has just gone over to a similar system. it is beyond me how people can afford to retire in sa with ever escalating medical costs, and no govt pension to speak of. then of course there is a fact that probably of the population are unemployed

i think the governmant (HAHAHAH) needs to review its approach to retirement. There should be more aggressive tax breaks for individuals and companies. For eg I used to work in the UK and the tax breaks for contributions into a pension fund were material and the tax breaks for companies’ contribution equally so. As a result I had a 15% contribution and for every £1 above that the company matched my contribution. In the long run foregoing some tax now is cheaper for the government than supporting retirees for many years.

I also think that the obsession with “total cost to company” in SA is harmful to pension contributions as it becomes a top down calcalation and it encourages people to squeeze the pension contribution to take home as much as they can. I jobs were advertised on salary with an overriding assumption that say 10% of that salary would be contributed to the pension oevr and above the advertised amount, people wouldnt give it a second thought.

A pension scheme in the hands of the private sector is nothing but a recipe for old age poverty. Your future is in the hands of greedy CEO’s and unscrupulous investment firms…

My solution, every South African whether educated or not. In formal employment or not must put away a mandatory 10% of whatever earnings he/she gets in his young life. This money is to be invested in a sovereign fund… In line with the “mubadala”. this money should go to infrastructure development and maintenance. Eskom would get funding from such monies. this money can be invested in equities both locally and off-shore. We can use it to buy foreign debt, bonds even businesses overseas. The PIC could be the commissioning agency, they have a good track record. SARS should be the collecting agency, no doubt as their abilities in that area, won’t you say? then anyone can choose to retire anytime from age 55. and continue to be paid a monthly income as the last month he leaves his employment. Those who never had the good fortune of a job will fall within the states pension scheme, but it will be at a more humane rate as more retirees will have a lifetime of contribution in the sovereign fund.

I am aware that such system would need at least a decade to be viable, but we must start now. 2025 – 2030 is not a long time to set as a target.

I could not agree less with you.
A Pension Fund (in the private sector) will provide you with a commensurate pension (commensurate with your salary and period of membership) – as long as you stay with this company – OR preserve the benefit when you change employment. Full vesting rights (you get your accumulated contributions and the employers net accumulated contributions) were entrenched many years ago
This is the first mistake people make – they switch jobs and cash in the Pension Contributions – then complain when they do stop working that they don’t have much of a pension.
Just 1 example. My father worked on the mines for 45 years and drew a pension for 22 years prior to his death, my mother has subsequently been in receipt of a pension for 11 years, this will stop at her death.
People are too quick to bad mouth a Pension Fund without having a good understanding of what they are talking about.
And no – I do not work in the Savings / retirement / insurance industry!

This topic, like many others, speaks to the problem of financial literacy, or the lack thereof, of it in S.A.

The average South African can barely manage a budget or just what’s in their wallet, for that matter…..
Ehhh, I heard you mention pension funds, yes, what was that about them ?

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