If the average active fund member continued contributing to their retirement fund at their current rate until they retired, they would only earn an income equal to about 40% of their last salary in retirement.
This is one of the findings of the Alexander Forbes Retirement Fund Member Watch Survey, a quantitative piece of research covering just over a million members belonging to 2 030 employer clients.
The average replacement ratio – percentage of final salary just before retirement received as an income in retirement – of the 7 200 members who retired during the year to March 31 was 28.8%.
“In other words, for every R10 000 that somebody was earning pre-retirement, their pension is R2 880,” says Michael Prinsloo, managing executive of research and product development at Alexander Forbes.
This amounts to a reduction of roughly 70% in a person’s income, and thus lifestyle, in retirement. The question is whether people can handle this type of reduction, he says.
Admittedly, some retirees may have other retirement assets from which to draw an income, and the reduction may be overstated, but because only 8.7% of members preserve their benefits when changing jobs (and there hasn’t been a significant change in this trend), the assumption is that the pension benefit will be the only source of income for a significant portion of retirees and that they will have to supplement their income in some other way.
The pie chart below shows a breakdown of the actual replacement ratios achieved by retirees.
According to the survey, only around 6% of the total membership can expect a replacement ratio of more than 75% of their pensionable salary in retirement. Pension funds generally target a replacement ratio of around 75%.
Prinsloo says non-preservation remains a significant problem. Although preservation has improved by about 4% per annum over the last three years, the current rate of 8.7% is still lower than the 11.5% reported in 2012.
“We’ve won a few battles. We’ve lost a few battles, but we are not yet winning the war in terms of getting people to a reasonable retirement outcome.”
The chart below shows the percentage of members in various age groups who preserved their retirement benefits when changing jobs in the 12 months to end March 2018 (blue bars) and compares it to the situation in 2012 (orange line).
Prinsloo says more people are leaving jobs each year, which may be a result of the changing world of work where people are expected to do more jobs throughout their careers, but each of these exits provides an opportunity for people to cash out their benefits.
A machine-learning analysis conducted using data around exits over the last three years identified five factors that influenced the level of preservation. These include the size of the fund credit, the industry sector, the reason for leaving the fund, access to financial advice, and whether the fund offers a preservation solution.
The size of the fund credit plays a significant role in people’s decision to cash out their benefits – 61% of those who chose not to preserve any of their benefits had R25 000 or less (when the amount is R25 000 or less, no tax is payable on withdrawal), and 37% had a benefit of between R25 000 and R660 000 (where 18% tax is payable).
Although government increased the tax deduction for retirement contributions to 27.5% of taxable income or remuneration in 2016, the average total contribution as a percentage of pensionable salary has reduced slightly, from 14.2% in 2015 to 14.11% in 2018.
While salaries have generally grown faster than inflation, investment returns have not kept pace with salary inflation.
“[Investment returns] actually need to beat your salary inflation, because that is where you are generating wealth in order to maintain your lifestyle post retirement,” Prinsloo says.
On a positive note the survey shows there has been a reduction in the number of members who are making their own investment choices, but this also means there is a lot of responsibility on trustees to recommend appropriate defaults. Default regulations require retirement funds to implement a default investment, preservation and annuity strategy by March 1, 2019.
Another silver lining is that the most common retirement age has increased from 60 to 65 from five years ago.
“We’ve seen a very solid trend of employers actually increasing retirement age.”
The trend mirrors global developments where defined benefit and state pension funds are trying to reduce their pension liabilities. In South Africa, most funds are defined contribution funds, but allowing people to work longer enables them to save five more years, while simultaneously reducing the number of years they have to live off their funds in retirement (assuming they pass away at the same age in both scenarios).
Prinsloo cites an example of one client where the retirement age was increased from 60 to 65 – the expected replacement ratio jumped from the mid-40s to the mid-60s, thereby increasing the expected pension by around 50%.
While various solutions have been proposed for South Africa’s dire retirement situation, some of which have found their way into legislation, Prinsloo says committing a small additional portion of future salary increases to contributions can make a big difference over time. In the US, this is what the Save More Tomorrow initiative is trying to achieve.